In a recent magazine publication an article caught by eye. They had put together a list of “10 Must-Have Shares in a Tricky Market”. The list includes picks that “provide a mix of balance sheet strength, exposure to upside growth potential and an ability to weather any further erosion in economic conditions”.
The chosen stocks were all well-known, highly reputable, blue-chip companies. All the supporting evidence allowed me to conclude that “yes indeed” the people writing the article were extremely accurate and intelligent. It all made sense.
But unfortunately, this is where the Stock Market is poorly understood. The Stock Market is an amazingly efficient mechanism whereby all the available information on anyone company can quickly be priced into a company’s stock. Therefore, shouldn’t all the good news and qualities of the company’s “picked” by the article be already factored into the share price? The market already knows that these are solid companies with good prospects. But does that make them good investments? It’s a different thing.
A good company often is priced at a premium to the market.
And besides, as we’ve seen over the past couple of years, there’s no guarantee anyway that idiosyncratic risk will not mess up your “safe” blue chip gamble (Babcock and Brown for instance).
This is why a concentrated portfolio of blue-chip stocks provides no guarantees. You are simply taking non-systematic risks that you are not rewarded for.
The answer is to diversify, accept that good prospects are almost always in the price already and to understand that low prices relative to fundamental factors mean higher expected returns. The mix of “good” and “bad” companies in your portfolio will depend on your appetite for risk.
Julian McLaren is a Representative of the Shadforth Financial Group (AFS Licence No. 318613) Julian may be contacted on 69317488. This is general advice and readers should seek their own professional advice in regards to their individual circumstances. Comment on this article at http://thenakedinvestor.blogspot.com
Wednesday, June 30, 2010
Thursday, June 17, 2010
Hedge Fund Meltdown
This week on ABC TV the Current Affairs programme 4 Corners ran a story on the Australian based hedge fund Basis Capital. The premise behind the story was that the Hedge fund had lost a significant amount of capital for its investors based on a dodgy deal with the US Investment Bank Goldman Sachs. Caveat Emptor comes to my mind but we’ll let the courts decide that matter.
Of more interest to me was the fact that two investors in the Basis Yield Fund were interviewed and asked if they were aware what the fund had invested in. Of the two investors interviewed, one had been recommended the fund by a Financial Adviser, and the other had chosen the fund himself. So how obvious was it that the Basis Yield fund was not the safe fixed interest investment that some touted it as? I decided to Google and get a copy of the Product Disclosure Statement (PDS) dated 2nd April 2007 (just 3 months before it went belly up).
What I like to look for is Red flags that would indicate the riskiness of the investment or otherwise. This is important because all PDS’s have to be approved by the Australian Securities and investments commission (ASIC) and they will happily approve a PDS if the risks are disclosed.
It did not take long for the alarm bells to start ringing. It was clearly disclosed that;
1. The fund invested in a sole fund registered in the Cayman Islands;
2. The fund invested in CDO’s (Collateralised Debt Obligations) including the equity tranche of structured credit special purpose vehicles which are often the first loss position in event of default (much like an ordinary share);
3. The fund used LEVERAGE (Borrowings) to further diversify the portfolio. The PDS clearly stated that any forced selling of this portfolio would result in capital loss;
4. In the calendar year 2006 the fund returned 26.41% before fees of 6.08% leaving the investor a return of 20.33%;
5. The ratings of the securities held show that 61.93% of the portfolio was invested in “unrated securities”. There were no AAA, AA, or A securities at all!
So to me, it was obvious that with such high returns, a large amount of risk had been taken. To put in perspective, in the same calendar year (2006) a diversified portfolio of AAA bonds returned about 4.61%. High fees are also a warning sign, particularly when performance fees are involved as this may encourage risk taking for the sake of trying to outperform. The fact that the fund was using borrowings to enhance return was also a big warning sign. Borrowing can magnify the gains and in this case magnified the losses.
The simple rule is that risk and return are related and you should only take on risks that you are rewarded for. Taking extra risk in fixed interest portfolios quite often does not result in the extra reward that you are expecting. Was the Basis yield fund safe? – quite clearly, the PDS states that it is not.
Julian McLaren is a Representative of the Shadforth Financial Group (AFS Licence No. 318613) Julian may be contacted on 69317488. This is general advice and readers should seek their own professional advice in regards to their individual circumstances.
Of more interest to me was the fact that two investors in the Basis Yield Fund were interviewed and asked if they were aware what the fund had invested in. Of the two investors interviewed, one had been recommended the fund by a Financial Adviser, and the other had chosen the fund himself. So how obvious was it that the Basis Yield fund was not the safe fixed interest investment that some touted it as? I decided to Google and get a copy of the Product Disclosure Statement (PDS) dated 2nd April 2007 (just 3 months before it went belly up).
What I like to look for is Red flags that would indicate the riskiness of the investment or otherwise. This is important because all PDS’s have to be approved by the Australian Securities and investments commission (ASIC) and they will happily approve a PDS if the risks are disclosed.
It did not take long for the alarm bells to start ringing. It was clearly disclosed that;
1. The fund invested in a sole fund registered in the Cayman Islands;
2. The fund invested in CDO’s (Collateralised Debt Obligations) including the equity tranche of structured credit special purpose vehicles which are often the first loss position in event of default (much like an ordinary share);
3. The fund used LEVERAGE (Borrowings) to further diversify the portfolio. The PDS clearly stated that any forced selling of this portfolio would result in capital loss;
4. In the calendar year 2006 the fund returned 26.41% before fees of 6.08% leaving the investor a return of 20.33%;
5. The ratings of the securities held show that 61.93% of the portfolio was invested in “unrated securities”. There were no AAA, AA, or A securities at all!
So to me, it was obvious that with such high returns, a large amount of risk had been taken. To put in perspective, in the same calendar year (2006) a diversified portfolio of AAA bonds returned about 4.61%. High fees are also a warning sign, particularly when performance fees are involved as this may encourage risk taking for the sake of trying to outperform. The fact that the fund was using borrowings to enhance return was also a big warning sign. Borrowing can magnify the gains and in this case magnified the losses.
The simple rule is that risk and return are related and you should only take on risks that you are rewarded for. Taking extra risk in fixed interest portfolios quite often does not result in the extra reward that you are expecting. Was the Basis yield fund safe? – quite clearly, the PDS states that it is not.
Julian McLaren is a Representative of the Shadforth Financial Group (AFS Licence No. 318613) Julian may be contacted on 69317488. This is general advice and readers should seek their own professional advice in regards to their individual circumstances.
Friday, June 11, 2010
Super Stupidity
The “Super profits” mining tax is currently a political hot potato for the Rudd Government as it is their silver bullet solution to bring the Budget back into surplus. What is also becoming apparent is that most people have a poor understanding of how it works.
The reality, however, is the way the tax works is quite simple. The 40% tax is set to replace the existing Royalties scheme which is a rent charged to mining companies by our State Governments which accounts for the use of the resources.
The Resource Super Profits Tax (RSPT) proposal allows a mining project to deduct the costs of extracting the resources from the price they sell the resources at. This “super profit” is taxed at the rate described above. For example, if the “Super Profit” is $100 then the new tax will deduct $40 from the net revenue.
But here is the sting as the tail. The Mining Company will still have to pay the Company Tax rate after the RSPT is deducted. That is, a further 30% tax may be deducted. This could be applied to the remaining $60 left over or a further $18. This would result in $58 in tax being paid which is the 58% rate that is being thrown around at the moment (However, keep in mind the Corporate tax rate is reducing to 28%).
But there is a flipside to this, which the government claims will encourage Mining Investment but critics claim will severely increase the downside risk to government expenditure should a mining boom collapse. The flip side is that the government will allow a 40% tax credit to Mining Project losses and this may be carried forward to offset future “super profits”. Each year that this credit is carried forward the Mining Project will be able to increase this credit by 6%. This is the mysterious 6% bond rate that is being discussed as the threshold on which the tax cuts in – which has not been reported correctly.
And that, ladies and gentleman is it! The government rightly points out that the existing system is not quite perfect so after consultation with the miners it is hoped that a compromise can be found to bring confidence back into the mining sector.
Julian McLaren is a Representative of the Shadforth Financial Group (AFS Licence No. 318613) Julian may be contacted on 69317488. This is general advice and readers should seek their own professional advice in regards to their individual circumstances.
The reality, however, is the way the tax works is quite simple. The 40% tax is set to replace the existing Royalties scheme which is a rent charged to mining companies by our State Governments which accounts for the use of the resources.
The Resource Super Profits Tax (RSPT) proposal allows a mining project to deduct the costs of extracting the resources from the price they sell the resources at. This “super profit” is taxed at the rate described above. For example, if the “Super Profit” is $100 then the new tax will deduct $40 from the net revenue.
But here is the sting as the tail. The Mining Company will still have to pay the Company Tax rate after the RSPT is deducted. That is, a further 30% tax may be deducted. This could be applied to the remaining $60 left over or a further $18. This would result in $58 in tax being paid which is the 58% rate that is being thrown around at the moment (However, keep in mind the Corporate tax rate is reducing to 28%).
But there is a flipside to this, which the government claims will encourage Mining Investment but critics claim will severely increase the downside risk to government expenditure should a mining boom collapse. The flip side is that the government will allow a 40% tax credit to Mining Project losses and this may be carried forward to offset future “super profits”. Each year that this credit is carried forward the Mining Project will be able to increase this credit by 6%. This is the mysterious 6% bond rate that is being discussed as the threshold on which the tax cuts in – which has not been reported correctly.
And that, ladies and gentleman is it! The government rightly points out that the existing system is not quite perfect so after consultation with the miners it is hoped that a compromise can be found to bring confidence back into the mining sector.
Julian McLaren is a Representative of the Shadforth Financial Group (AFS Licence No. 318613) Julian may be contacted on 69317488. This is general advice and readers should seek their own professional advice in regards to their individual circumstances.
Thursday, June 3, 2010
Resource Tax
http://blogs.abc.net.au/nsw/2010/06/explaining-that-tax.html?site=riverina&program=riverina_breakfast
Tuesday, June 1, 2010
Don't Worry, Be Happy
There is a lot to worry about for investors at the moment – mining taxes, Euro zone debt fears, Middle East tension. What is an investor to do?
I have been in the Financial Planning Industry for over ten years now and I must say, it doesn’t get much better than this (although memory dulls the pain).
Let’s start by casting our minds back to the Asian Financial Crisis in 1997. This was followed by the Russian debt crisis in 1998 and the collapse of the ironically named hedge fund – Long -Term Capital Management.
In 1999 all we had to contend with was the Y2K bug. Remember that? Planes were going to fall out of the sky! With that safely behind us, the internet bubble burst in the year 2000 wreaking havoc to speculative investors around the world. In 2001 we had the terrorist attacks in the United States on September 11.
In 2002 the United States had another Terrorist attack which was home grown. It came in the form of “the smartest guys in the room” at energy company Enron Ltd. They caused a market meltdown as investors questioned the honesty of corporate America.
And in 2003 we had the war on Iraq......are you starting to get the picture?
This perception of fear has been heightened in the past decade or so with the emergence of a Media focused on the 24 hour news cycle. We have more information at our finger tips (the internet) and a quick glance at Pay TV shows even locally we have access to three 24 hour Business News channels. This is a lot of content that needs to be filled each day!
For investors there will always be something to worry about. However, what we can learn from history is that maximum financial opportunity occurs when investors are most fearful, or put another way, future expected returns are at their highest when prices are at their lowest.
The future is a series of unpredictable events so if an investor would like to achieve a return greater than the risk free rate, they had better get used to some bad news.
Julian McLaren is a Representative of the Shadforth Financial Group (AFS Licence No. 318613) Julian may be contacted on 69317488. This is general advice and readers should seek their own professional advice in regards to their individual circumstances.
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