Newsletter February 2009

February 2, 2009

I have spent time since returning from the Christmas break working on recommendations for a number of clients with money to invest. It is clear that the next year is going to be one of compromise. We are now in an environment of low interest rates, relatively high inflation, and a volatile sharemarket. This is making it difficult for investors to:

  • Generate the income they require
  • Keep pace with inflation
  • Stay within their risk profile

Satisfying two out of the three requirements is generally easy enough, however satisfying all three is now becoming harder and harder. A year ago we were enjoying interest rates of 8.00% to 10.00% without taking undue risk. The Official Cash Rate has been cut to 3.50% and this has significantly affected bank deposit rates and yields on corporate bonds. Those who took advantage of fixing longer-term rates last year will be pleased with that decision; however those with money falling due now will struggle to generate the income they have enjoyed previously.

Inflation has just dropped from an eighteen-year high of 5.10% to its current rate of 3.40% and this compounds the problem faced by fixed-interest investors. Once you have paid your tax on a 5.00% term deposit you are left with very little income if you want your capital to grow in line with the cost of living. I expect inflation to fall in the medium-term as the recession takes hold in New Zealand; however longer-term inflation could pose problems as our Government attempts to stimulate the economy.

Low returns force investors to seek out other opportunities, and this generally involves taking more risk. The sharemarket is offering very good yields at present; however there is no certainty around those yields. Corporate earnings are probably going to be impacted across most sectors through this year and that is likely to result in reduced dividend payouts.

How investors reconcile these factors needs to be decided on an individual basis. The options are:

  • Spend less
  • Mine your capital for a period
  • Take more risk

Spending less is not particularly palatable but is at least something we have direct control over. Human nature dictates we usually spend at least what we earn (and as events of the last few years have shown some spend significantly more than they earn). How many people actually keep accurate records of their spending? You may be surprised if you did.

Mining your capital can be likened to mining the fertility of a farm. How important is it that your capital increases in value each year? Can you spend some of your capital and still maintain the long-term standard of living you desire? Unfortunately the hardest part of this decision is the fact we don’t know when we are going to die. If we did know it would be a simple case of doing the maths and spending your last dollar on D-Day. Something I find disturbing is the number of people I see of my parents’ generation who feel an obligation to leave their wealth to their children. These people have worked hard all their lives and are now going without in order to leave a legacy for their kids. Why is that? In my opinion we owe a debt to our parents, not the other way around. We enjoy a far better standard of living than our parents and grandparents ever did and that will continue ad finitum. Ensuring your capital keeps pace with inflation is a worthy goal, however make sure you are doing it for the right reasons.

Your aversion to risk is not something you can turn off and on – it’s something that should be reasonably constant, with less risk being taken as you age. Theory suggests we take more risk when we are younger because we have more time to ride out the volatility of riskier investments. In my opinion sharemarket investments require at least a five-year time frame, so don’t tie money up in shares that you may require in the short-term.

Fixed Interest

As we mentioned in our last newsletter we expect to see a number of good quality fixed interest opportunities come to the market in the early part of this year. Corporates are seeking money from the public in preference to more expensive bank funding.

Fonterra

Fonterra have issued a prospectus for an offer of $300 million (plus unlimited oversubscriptions) of unsecured, unsubordinated, fixed rate bonds. 

  • Minimum interest rate of 7.75%
  • Maturity date – 10 March, 2015
  • Interest paid quarterly
  • Minimum investment of $5,000
  • Standard & Poors credit rating of A+
  • Closing date – 09 March, 2009

The Standard & Poors rating report for this issue notes the fact that interest payments to bondholders have precedence over payments to suppliers of milk. “Core to the ratings is Fonterra’s co-operative structure, which means creditors benefit from the protection of priority payment, with milk payments to supplier-shareholders determined after expenses.” This bond issue will be very popular – Fonterra is New Zealand’s largest company and 7.75% represents a good rate in the current environment.

PLEASE CONTACT OUR OFFICE AS SOON AS POSSIBLE IF YOU WOULD LIKE TO RESERVE AN ALLOCATION OF THIS BOND

 We expect further issues though February and March from:

  • Contact Energy
  • BNZ
  • Auckland City Council

Rates for these bonds are yet to be determined, however if you are interested in these please let me know so we can ensure an adequate allocation.

Shares

The sharemarket has posted a modest gain since reopening in 2009 – up 2.00%. The volatility is not as pronounced as it was through the latter half of 2008, although volumes still remain low. We are seeing interest being shown in the traditionally higher yielding stocks as investors look outside bank deposits for a return on their money. Yields of some shares on our market are listed below:

Company                                                Price         Dividend (Cents/Share)        Gross Yield

AMP Office Trust                                       0.95                       7.67                                  8.84%

Auckland Airport                                       1.85                       8.20                                  6.54%

Cavalier                                                      1.92                     20.00                               15.39%

Contact Energy                                          6.73                     28.00                                  6.21%

Fisher & Paykel Appliances                   1.27                      14.00                                12.40%

Fletcher Building                                      5.52                      48.50                                12.95%

Freightways                                               2.85                       18.75                                  9.82%

Goodman Property Trust                        0.95                        9.99                                 10.64%

Hallenstein                                               2.19                       27.00                               18.32%

Michael Hill                                               0.52                         3.20                                 9.18%

Opus International                                  1.08                          7.10                                 9.93%

Pumpkin Patch                                        0.92                          7.50                              12.30%

Restaurant Brands                                0.64                            6.50                              14.45%

Sky City Entertainment                          3.02                          21.50                            10.40%

Steel & Tube                                            2.80                          19.00                              9.95%

Telecom                                                   2.64                           28.00                           14.60%

Vector                                                       2.17                           13.25                              8.79%

These yields are based on today’s share price, and the dividends paid in the previous year. The gross yield is calculated after any imputation credits are added to dividend payments. Obviously these yields cannot be guaranteed as dividend payments fluctuate with market conditions.

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