Newsletter Christmas 2009

December 23, 2009

Government Regulation

Much has been written in the newspaper recently about the standard of financial advice in New Zealand, and the imminent Government regulation of the advice industry. I expressed my views in the August newsletter, and feel it is worthwhile touching on the subject again. It’s an issue investors should keep abreast of because it has the potential to change the way investment advice is delivered and paid for.

There have been more calls for the banning of commission payments to financial advisers recently. The Sunday Star Times ran an article explaining how the Capital Markets Development Taskforce is poised to recommend law changes preventing financial advisers from taking commissions. The U.K has already committed to banning commissions, and Australia is considering similar moves. As I said in the August newsletter I believe banning commissions is short-sighted, and feel investors should be able to choose for themselves how their adviser is remunerated. Disclosure is paramount however, and investors need to be able to assess if there is a potential conflict of interest in the advice they are receiving. There are different rates paid by the various companies, and arguably there is the potential for advisers to let self-interest override the needs of their clients. The Capital Markets Development Taskforce has said the new law will impose a clear fiduciary duty requiring advisers to act in the best interests of their clients. Call me old fashioned but I wouldn’t have thought we need a law to stipulate that. I plan to own this business for the next 15-20 years and the only way I’m going to make money from it is to put investors’ interests ahead of my own each and every day.

The negativity around commissions has arisen from the managed funds industry and the meltdown of the finance company sector. For a number of years inexperienced advisers (largely insurance salesmen) have been selling their “ABC Super-Dooper International Growth Fund” or their “ABC Diversified Income Fund” and receiving ongoing commissions for as long as the money remains invested. More often than not these funds have performed poorly, however the adviser continues to benefit regardless. More recently the finance company failures have highlighted some ugly practices, with advisers clearly funnelling investors’ funds into an area that generates the greatest return for the adviser. Removing commissions isn’t going to solve these problems – there will always be dishonest and incompetent advisers and there will always be poor investment products. We also receive commissions from new issues of shares and bonds, yet this doesn’t seem to generate any negative publicity whatsoever. Maybe it’s because the companies involved (Rabobank, ANZ, Contact Energy, BNZ, Fonterra, Auckland Airport etc) have a much higher standing in the investment community than the finance companies. Nevertheless the method is identical – “sell this product to your clients and we will pay you a commission.” My job is to assess the merits of all these types of offerings (shares, bonds, finance company debentures, Government bonds, KiwiSaver, etc) and determine whether or not they fit the needs of our clients. To me the commission issue is irrelevant – first and foremost I want products that benefit my clients – if I do that on a consistent basis, I stay in business.

What are the alternatives? The most common method of remuneration in the financial planning industry is based on “funds under management.” Investors pay their adviser a fee based on the value of their investment portfolio. This is fine as long as the adviser is providing you with “value.” They should be actively managing your portfolio for you if you are paying them an ongoing fee. What tends to happen, however, is that as advisers build their business they cull out the clients with less money to focus on those that can generate the most return. Advisers would be reluctant to take on clients with small sums of money – possibly the very people that need financial advice the most. A second alternative that seems to be gaining traction is simply charging for the time spent advising a client, much the same as a lawyer or an accountant does. My concern with this is the amount of time I spend on things other than directly dealing with clients. Much of my day is spent reading and researching, and that time would need to be charged accordingly. I might take a call, for example, for advice on whether or not to take up the PGG Wrightsons’ rights offer. That call might last five minutes, but what about the hour I have spent reading the prospectus and monitoring the prices of the rights and the underlying shares?  In my opinion this method of charging would restrict many people from seeking financial advice – again the very people that need advice the most.

I prefer the transaction-based model where investors pay brokerage (or we receive a commission) based on each transaction entered into. I feel it offers the best value for investors. Whatever method is used there will always be one group that subsidises others. Wealthy investors would prefer to be charged an hourly rate; investors with small sums would prefer the transactional model. What I need to do is ensure I am offering investors value, whilst at the same time earning a fair income – I’m not doing it for nothing! I would be interested in your views on how best to pay for financial advice – please let me know.

Expensive Shares?                           

I often hear people suggest they couldn’t possibly buy a share valued at, for example, $50, because it is too expensive. Their rationale is that you don’t get as many shares for your money when buying higher priced shares; or a 10cent share has a far greater chance of doubling in value than a $50 share. This is a commonly held view, however is completely irrational. The important factors that determine share price are the number of shares on issue, company earnings, dividends paid, and the future prospects of the company. If we look at two different shares as an example we can draw some comparisons.

 

                                                                        Price               Dividend Paid            P/E Ratio

Fisher & Paykel Healthcare                      $3.33                 17.71 cents                 23.90

Westpac Bank                                             $28.95               145.94 cents               18.10

 

Let’s assume we have $20,000 to invest. We would receive 6006 shares in Fisher & Paykel Healthcare, or 690 shares in Westpac. If Fisher & Paykel Healthcare continues to pay a dividend of 17.71 cents we would receive income of $1,063 – a yield of 5.32%. If Westpac continues to pay a dividend of 145.94 cents we would receive income of $1,006 – a yield of 5.03%. As you can see there isn’t much between the two companies in relation to their ability to generate income; even though their share prices are so far apart. Warren Buffett’s “Berkshire Hathaway” shares are currently trading on the New York Stock Exchange for $1,000 each! “Apple” shares were trading at $70 in 2006, and peaked at $195 in December 2007.

Office Hours

We will be closing over the Christmas and New Year Period. The office will close on December 23rd at 12.30 and will reopen on January 11th. I will be in the office briefly each morning to clear mail so please don’t hesitate to ring if you need something done. Leave a message on the answer phone if necessary – I will clear these each day. Also don’t hesitate to ring me at home or on my mobile phone at any time.

I sincerely hope you all have an enjoyable break over the Christmas and New Year period. I plan to relax at home with family, and will be working desperately to stay ahead of my boys in the back-yard cricket standings.

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