Go figure!

I am thoroughly convinced that the economic world is simply irreconcilable. Here’s a summary of the week just past.
On Friday morning I was surprised to hear that the stock market in the USA had fallen due to strong jobs growth! Hang on, isn’t the USA relying on stronger employment to buoy the consumer who will spend more, lifting confidence and thereby start paying back their home loans and perhaps spark recovery in the housing market (the core of the current problems). Nope, apparently this was going to reduce the chance of the Federal Reserve printing money and thereby closing an opportunity for easy money and inflation.
But it gets worse. This week in Japan the Central Bank dramatically cut interest rates.....from 0.1% to between 0% and 0.1%. Goodness me, I doubt this will make much of a difference but who am I to argue against their collective wisdom – given that the Japanese economy has deflated for 20 years now – more of the same? Why not?
Also there was an interesting conversation this week about the banks and warnings for them not to lift interest rates outside the normal RBA increases - intimidation? Both sides of politics are guilty of this but would any of them actually take any action? Let’s imagine a “Super Profits” style tax was imposed on our banks. The most likely result of this action would be a flight of foreign capital from our shores resulting in a huge increase in banks funding costs and that would result in...oh dear... higher interest rates.

But hang on, if it’s no good for banks to increase costs to consumers why is it OK for Energy companies to increase costs without any repercussions. From 2005 to 2010 Electricity prices have increased by 61.3% in Sydney. A recent article on Business Spectator by Robert Gottliebsen suggested that power prices may actually quadruple over the next 4 years.

Directly relating to this, the State Government is set to axe its solar energy scheme. In this scheme, people that install solar panels can sell power to the grid for 60 cents per kilowatt hour and then buy it back for a quarter of that. The government is forcing Energy Companies to pay for the difference and all of us who don't have solar panels are thereby paying for this with increased BILLS. The irony is that the greatest demand for household power comes in the evening when the sun don’t shine. As a result, the Coal Fired Power Stations remain at full capacity!

It is also a regressive system as only wealthy people can afford to install the panels and poorer people end up paying for it with higher energy bills. So once again we find a government action with the best intentions being implemented with the worst outcomes. I would suggest you ain’t seen nothing yet!!!

So in conclusion it has been a crazy week. The award for the most unforgiving job in the country goes to all the Economists who predicted a rate rise this week. Forecasting is certainly a mugs game.

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

Choice?

Is too much choice simply too much for some people to handle these days?

Interestingly, the more choice we have, the more disappointed we subsequently become. This is actually contrary to most people’s belief that the more choice, the better. Let’s take for example a simple trip to the ice cream shop – there are so many flavours to choose from now. Inevitably you choose something and take the first bite and then wish you had chosen the other flavour. The same applies at the restaurant, and how about choosing the colours to paint your house. How many shades of white are there for goodness sake?

So despite the fact that economic theory suggests that we are rational economic agents who know their own business best, perhaps this is simply not true when investing. This is why the government is implementing MySuper, a low cost and no frills solution for those of you who show high levels of apathy towards their superannuation and retirement.

Guess what, in my experience this is absolutely correct. To this stage I have not been convinced that the majority of Australians would not be advantaged by investing into a MySuper option. The reason for this is that most investors overestimate their ability to choose good investments. Furthermore, they are also prone to making investment decisions based on past performance rather than an intellectual framework. Finally, they also get caught up in the fear and greed cycle resulting in taking less risk when things are bad and taking more risk when things are good which is unfortunately the incorrect course of action (Warren Buffet states "Be fearful when people are greedy, be greedy when people are fearful").

The Dalbar study supports this. In the 20 years to the end of 31 December 2009, the S & P 500 index in the USA averaged 8.2% per annum wherea’s the average investor achieved a return of just only 3.17% over the same time period.

Someone who wants to really make a difference to their long term goals should consider paying for some advice but I must warn you...achieving your long term goals rarely has much to do with picking the right investments - it is more about understanding the key financial levers that affects your long term outcomes including income, expenses and asset allocation.

If you think that by chopping and changing your investments and trying to pick the next winner is your path to financial prosperity, I say good luck!!!!

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

Emotions - your greatest enemy

Here is an interesting thought.
When the price of a good or service goes up, let’s say Banana’s or Petrol, our first inclination is to buy less. Right?
Then why do we not apply the same philosophy to financial assets? If the price of a listed share goes up, why are people more inclined to buy it......and looking at the reverse, if the price falls, they sell it. The same can be said for managed funds. Investors and Financial Planners are more inclined to purchase managed funds that have performed well over the past 12 months.
The problem is, people appear to incorrectly extrapolate past price changes into the future. This is unfortunate for so many reasons, not least the fact that there is overwhelming evidence to suggest that this behaviour destroys wealth. The Dalbar Study in the USA has found that over the 20 year period to 31 December 2009 the US Sharemarket S & P 500 Index had an annual return of 8.2% whereas the average stock fund investor averaged a paltry 3.2% (barely above the rate of inflation).
Investor behaviour is shaped by the false belief that there are market guru’s that can predict the future. This faith is placed in stock brokers, economists, managed fund analysts and Financial Planners. If the truth be known many investors are none the wiser as they do not have the ability to benchmark or “judge” their investment performance with their peers.
Poor asset allocation decisions and market timing nightmares also compound the problem.
Emotion is your greatest enemy. When people are most fearful, future expected returns are actually at their highest. Knowing this, why are people tempted to withdraw money from the share market at this time? Ultimately, investors will only succeed if they have the right plan and discipline in place.
Charles Kindleberger once wrote “There is nothing so disturbing to one’s well being and judgement as to see a friend get rich”. This is a very poignant statement, but should be a lesson to people that we need to constantly battle our emotions and biases and this sometimes needs the help from an expert.
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

Visionary or White Elephant?

The Federal Labour government are proposing that we spend $43 billion on the National Broadband Network (NBN). It is a being promoted as a Nation Building project that will increase the productivity of Australia and lead us into the 21st Century. Is this fact or fiction?
I pride myself on the fact that I am a bit of a technical Luddite (by the way, the Luddites were a social movement of British textile artisans in the nineteenth century who protested – often by destroying mechanized looms – against the changes produced by the Industrial Revolution, which they felt was leaving them without work and changing their way of life) so I am not really impressed when people start discussing current speeds, data downloads (and uploads for that matter) and fibre optic cable. However, I acknowledge that to retain our status in the real world some areas of our economy require much faster broadband speeds.
But for me to really determine whether the NBN is a good idea or not I would like to see a fully researched Business Plan.
Unfortunately, a Business Plan has not been established for the NBN (well it sort of has but the government won’t let us see it). I assume this is due to a couple of reasons, one being the uncertainty of who will avail themselves of this new technology and also ultimately what it will cost. There is little doubt that when a government (of any political persuasion) is involved in large projects there appears to be cost blow outs due to overarching bureaucracy and the temptation for people involved to simply increase their prices.
New technology is currently being developed at a very rapid pace. A pace that has probably never been seen before. We cannot forget, however, the lessons of the past. New technology always results in over investments (think railway lines is the late 19th century) and wasteful spending. I also acknowledge that people will raise the Snowy Mountains Hydro project of an example of a large infrastructure Nation Building project but the facts show that the cost of the Snowy Hydro Scheme adjusted for inflation was only $6 billion (in 2004).
So I would suggest that we slow down on the project and have an honest and open discussion about the costs, the benefits and threats before we embark on what could be an expensive mistake. Some people have likened the NBN to a 4 lane highway. What we have to remember is that not every house in Australia needs a 4 lane Highway to their front door.
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 Madness of Crowds

Charles McKay’s eloquently stated in his book “Extraordinary Popular Delusions and the madness of crowds” (published in 1841), that “Men, it has been well said, think in herds: it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one”.
You will see, from time to time, this phenomena occur whether it be the Global Financial Crisis, the Swine Flu scare, Tulip mania, the Internet Boom and the list goes on. It is important for the individual to try and recognize these events and consider running against the herd and learning from past mistakes.
In the Late 19th century the world had witnessed a huge increase in the population in urban centres. In the USA the population of cities had increased by 30 million over the preceding 100 years of which half of that growth had occurred in just 20 years.
According to the new book “Super Freakonomics” by Steven Levitt & Stephen Dubner, this rapid population explosion in cities caused a huge “Emission’s” problem from the major mode of transport – Horses! Their Emission’s of course was manure. New York City alone was occupied by 200,000 horses at the turn of the 20th Century. It is said that these horses produced 5 million pounds of dung a day.
This was indeed a problem. Streets were lined with dung and huge mountains of horse manure were built up around the city on vacant blocks. The smell and the hygiene issues had authorities and residents in a state of panic.
Indeed in 1898 New York hosted the first international urban planning conference to try and address the issue facing cities around the world. The conference only completed 3 of the planned 10 days as no solution could be found.
But then, all of a sudden, the problem vanished. Not by imposition of a big new tax, or legislation banning horses, or an uprising of disgruntled citizens. It was solved by the invention of the automobile.
Levitt & Dubner put it down to this….”Humankind has a great capacity for finding technological solutions to seemingly intractable problems……”. And I have no doubt that this will apply to the current catastrophic scenarios that are allegedly facing us today!
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

Safety in the Market?

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

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.