Newsletter November 2008

November 3, 2008

The Global Bailout

Volatility, fear, panic, (and Government intervention) – all the things financial markets don’t like, and we have seen them all in the space of two months. Governments around the world clearly had to do something to restore confidence in the markets. Banks were too scared to lend to each other and there was the potential for a real meltdown amongst financial institutions. The problem with Government intervention is; often it sends all the wrong signals. We are seeing it now in New Zealand, as the Government guarantee of financial institutions unfolds. It was always going to be fraught with anomalies – who is included and who is excluded? Investment funds are flooding out of mortgage and managed funds in favour of banks and finance companies. AXA has just frozen a $225 million mortgage fund, pre-empting mass withdrawals. This is exactly what the Government was trying to avoid by including finance companies and building societies in the scheme. It seems the more the Government intervenes, the more they have to intervene. What would have been simpler in my view (I’m a recognised expert on economic policy!) was to guarantee people’s deposits at a specific date, and any investments made after that date carry the risk associated with individual institutions.

What effect will the massive global Government intervention have on us? My knowledge of economics is limited to a couple of introductory papers at university, and some practical experience following the crash in 1987. The theory tells me that central banks pumping billions of dollars into an economy causes inflation, and most financial shocks have been followed by periods of high inflation. The practical experience tells me high inflation is very beneficial for those who borrow money to invest in assets that grow in value, but very damaging for those with most of their wealth in cash. We may be entering a period of low interest rates coupled with a (relatively) high rate of inflation, and investors need to be aware of what effect this will have on their wealth. If all your assets are in fixed interest, and you spend all the income it generates, your wealth can be severely eroded by inflation.

Fixed Interest

Yields are falling in line with expectations, after the Reserve Bank dropped the Official Cash Rate to 6.50% on October 23. Unfortunately there have been no really startling fixed interest opportunities in the last couple of months. The Auckland Airport bond issue paying 8% for eight years was filled before we even received the hard copy of the investment statement. What that tells me is there is a large amount of cash in the banks looking for a slightly better return. The banks themselves have started issuing more debt, with the BNZ and the ANZ National Bank seeking to raise $50 million and $100 million respectively. However, instead of issuing new bonds they reopen an existing bond issue and investors buy them as if they were buying on the secondary market. For example, the BNZ reopened their 27 May 2015 8.675% bond. Anyone buying it now will receive the 8.675% coupon payment semi-annually until maturity in 2015, but they have to pay approximately $105 per 100 to get it. This gives you a yield of 8.00%. The banks are not paying brokerage to us so we must charge clients secondary market brokerage rates of 1% if they want to buy these bonds.

GPG Capital Notes

The 2003 GPG Capital Notes are due to mature in December, and GPG have offered investors the opportunity to either have the notes repaid in cash, or roll them over at a new rate of 9.00% for five years. GPG doesn’t need the money, hence the low rate. Their 2012 capital notes are trading on the secondary market at 10.50%, and there are a number of similar securities trading at those levels, so my advice would be to redeem the notes and look for somewhere else to put the money. A small selection of other opportunities includes:

Security                                                    Maturity             Rating            Yield      Price/$100

Kiwi Bonds                                              All terms                AAA              5.25%

UDC Telephone Call A/C                      At Call                    AA                7.65%

Sky City Entertainment                     15 May 2010                                  10.40%

BNZ Income Securities (PIE)             Perpetual                A+                                   $106.80

ANZ Perpetual Bonds                          Perpetual                A+                                   $104.75

Trustpower

Just as this newsletter was being finalised we were informed that Trustpower intends to make a bond offer. Indications are the issue will be $100 million of unsecured, subordinated bonds paying quarterly interest of 8.40% per annum. Please let our office now as soon as possible if you are interested in this issue.

Equities

At some stage the equity markets will stabilise and there will be a return to normality. With interest rates dropping and predictions of further falls, the sharemarket becomes a very real alternative for investing a proportion of your funds. I may be sounding like a broken record but I can’t emphasise enough how much you need to be aware of the effects of inflation. In twenty years time $1 million may only buy an average three-bedroom home. We are retiring earlier and living longer so we need our retirement funds to last much longer than in the past. Having some money in equities over the long-term “should” help your investments keep pace with inflation. I read an interesting article recently by Warren Buffett, probably histories most successful value investor. Here is a small part of that article.

“A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now. Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.”    

We receive daily research on New Zealand and Australian companies and will provide this to you on an individual basis. Current “BUY” recommendations include Fletcher Building, Contact Energy, Trustpower, Sky TV, Fisher & Paykel Healthcare, Sky City Entertainment, Rakon, Monadelphous, Nufarm, Woolworths, BHP. CSL and AGL Energy.

Please note that any recommendations made in this newsletter are fairly generic, and I recommend you ring and discuss your own situation if you are thinking of investing in any securities mentioned in the newsletter.

Capital Guaranteed Investments

Man Investments (OM-IP) and Liontamer are two companies offering equities-based investment products with capital guarantees. Liontamer tends to base their offerings on themes such as energy or emerging markets, whereas Man Investments follow the same investment strategy they started using in 1997. Their first fund launched in August 1997 has generated a compound return of 17.50% per annum, with claims that most of their funds have returned between 10% and 20% per annum since inception.

How do they offer a capital guarantee, especially if they are investing in equities? They invest a proportion of your funds in a secure bond (usually with a large bank) for the term of the investment. Let’s say the investment runs for eight years, you put in $10,000, and the company can buy an eight-year bank bond paying 8.00%. They would invest $5,402 in the bank bond which would grow to $10,000 with compounding interest by the end of the eight-year period. So from day one they know they can pay you back your initial investment. The remaining $4,598 is invested in shares and higher risk securities such as futures and options. The hope is that the amount invested in the high-risk part of the fund generates returns in the order of 20% to 30% per annum to bring the overall return up to an acceptable level. These funds can perform well regardless of market direction depending on the types of securities they buy. For example, share options allow you to make money if you predict there will be a drop in the price.

Liontamer uses the Belgian KBC Bank for its guarantee and Man Investments uses the Commonwealth Bank of Australia. In some cases a rising guarantee is employed, whereby once unit prices reach a certain level, a certain percentage over and above your initial investment is also guaranteed. Although getting your capital back at the end of an investment period is reassuring, if that’s all you get it’s actually a very poor return. This is something that seems to be glossed over by those pushing this type of product. If your $10,000 was invested in the bank bond at 8% you would have $18,509 at the end of eight years. The other point to note is any guarantee is only ever as good as the company offering it. However, Man Investments and Liontamer have both performed well since these funds were launched, and do provide opportunities when markets are volatile as they are at present. They would suit investors seeking growth over income, and those with a long-term view.

Both these companies pay high levels of brokerage to advisers. We rebate any brokerage over 2.00% on these products back to the client.

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