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1. No Greenshoots for Bondholders
2. Your Tax Refund Has Arrived
3. Illegal Early Access to your Super
4. Future Proofing your Business With Succession Planning
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Portfolio Managers
Investor Insights
September, 2009
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Welcome to the September, 2009 edition of Investor Insights.
Please feel free to forward this newsletter to any friends or associates that may find the information beneficial.
Index
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No Greenshoots for Bondholders
Greenshoots or not, there has been a profound change in the Australian and US equity markets since March this year, vindicating the actions of global central bankers to stem the systemic problems of the GFC. The resulting stock market rallies can best be explained as a direct result of those regulatory efforts and the likelihood that they have allowed us to avoid a complete global melt down.
In Australia rising share prices in quality stocks have brought the market back to where it might have been at the bottom of a “normal” recession and bear market. Further Australian sharemarket gains will depend on GDP growth and resulting earnings improvements – which if Ken Henry is correct will start to be seen perhaps as early as the end of this year, growing strongly in 2010 and 2011.
For now, with many shares seeming to be fully priced, investors have started to look again at bonds as a way to generate good returns with relatively low risk. That is likely to be a fool’s paradise, with the looming profound risks in the US and global interest rate markets.
For investors looking to protect their capital – as well as accessing good prospects for income and growth – in 2009/2010, we advocate:
• Good quality Australian “blue chip” shares, with a focus on defensive stocks like the banks and quality resource and energy stocks: these assets will benefit from Australian GDP growth and the renewed demand for commodities as global and Asian economies continue their recovery.
• Careful investment into growth economies such as the “BRIC” (Brazil, Russia, India, China), (either alone or in combination).
• Assets that provide a hedge against the prospect of rising inflation, such as gold.
• Exposure to commodities directly, through investment funds that are linked to the performance of those commodities.
China can rely on its huge cash reserves to fund its recovery programs but the US has to rely on massive increases in government debt. US government bond issues have increased dramatically in the last 12 months and will continue to ramp up as the GFC response packages are fully implemented. In a country that nearly collapsed as a result of its unsustainably high public and private debt levels, further debt issuance can only be achieved by paying higher and higher interest rates – and that is the source of the problem for investors in bonds and bond funds. In a rising interest rate environment, previously issued bonds that pay lower returns will suffer from falling capital value. Unless you can buy bonds directly and hold till maturity, you will lose capital by being exposed to bonds.
It’s not just the skeptics like Marc Faber that are predicting problems for bond investors. Mainstream portfolio advisers like William Keenan from Lonsec are making the argument to their clients, albeit in more moderate terms than Faber and think alikes such as Peter Schiff.
Keenan recently stated that “I think the rise in bond yields has the potential to turn nasty.” His assessment is that US bond rates will rise soon, and significantly:
“My belief is that the Chinese, Japanese and Russians are wary of buying anything longer than 5 years. Yes they are buying US treasuries but only short-term paper where they can be sure of getting their money back and limit any potential losses from falling USD and rising bond yields. Investors are becoming wary of 5, 10 and 30 year paper. Would you invest in US 30 year bonds at 4.6%? Do you think that is a good return for a Country that has public debt approaching 100% of GDP?”
The consequence of rising US bond issuance isn’t just that rates on new bond issues will rise. Look how enmeshed this is with other key parts of the financial markets:
· US property mortgage rates are linked to US government bond rates. Keenan notes: “If these yields continue to rise because no-one wants the paper, then mortgages will rise also”.
· The US Fed is managing interest rates by a process known as “quantitative easing” which means that it stands in the market to buy bonds at prices above par (implying a lower or even negative yield). To finance this, the US Fed prints money, increasing the money supply and devaluing existing money on issue. As Keenan notes: “If the Fed has to do this on a large scale to keep bond yields down then the US$ will weaken due to the large currency debasement that is going on by the US Fed monetising US Govt debt.”
The impact of a falling US$ flows into commodity prices, which are already starting to rise as stockpiles fall and economic growth resumes (see the article in this week’s Eureka Report on rising commodity prices). A falling US$ drives commodity prices higher, leading to higher inflation and even less demand for US$ denominated assets especially bonds. Keenan again: “Hence bond yields rise because of less demand AND fuel prices rise in the US. Very nasty.”
Keenan’s view is that the US inevitably will have to take some very harsh medicine – which does seem to be factored into the US political psyche with discussions this week in the US financial media that President Obama’s healthcare reforms will be shelved this year. As Keenan prophetically comments:
“The only way out of this dilemma is for the US Govt to face up to the fact that it cannot afford to keep racking up debt when it already has $10 trillion against an economy worth $14 trillion. It must reduce spending and /or increase taxes at some point soon. Both of which are unpleasant for the US economy and US consumers. This is why I do not expect a V shaped recovery (in the US) but a long L shaped flat period.”
Avoiding the risks of investing in the US, or in the bond markets that will suffer from collateral damage as the US rebuilds its economy, will be key to preserving and growing your wealth in 2009/10.
Source: Alpha Structured Investments
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HERE'S A THOUGHT . . .
"Positive thinking will let you do everything better than negative thinking will" ~ Zig Ziglar
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Your Tax Refund Has Arrived
Before you race out and spend those dollars on that new pair of shoes or the latest hi-tech phone follow top tax tips.
Tip 1: Pay off your credit card
Pay off some or all of your credit card. The quicker you pay off your credit card the less it will cost you in the long run.
Tip 2: Boost your super
According to a recent survey it costs singles around $38,000 a year to have a comfortable retirement and around $51,000 for couples? By boosting your super savings now you can work towards achieving the retirement lifestyle you want.
Money invested in your super today has longer to earn interest compared to money invested just before you retire. If you contribute $300 to your super fund each year for 30 years, your super could grow into $18,000 by the time you reach 60.
The other benefit to contributing to your super fund is that if you make after-tax contributions you could receive a government co-contribution. If your total income is $30,342 or less, the maximum co-contribution is $1,000, based on $1 from the government for every $1 you contribute.
Tip 3: Save your money and watch it grow
If you are dreaming of a holiday or a car why don't you open a high interest savings account and watch your money grow.
If you are saving for your first home, you could deposit your tax refund into a first home owner's savings account. The government will contribute an extra 17% of what you deposit into the account with a maximum $850 contribution if you deposit $5,000.
Tip 4: Pay some extra off your mortgage
If you have a home loan consider using your tax refund to pay off some of your mortgage.
Dollars paid into your mortgage will cut your interest bill, and can take years off your loan, especially if you start early.
Tip 5: Set aside your money for Christmas
Christmas is coming as well as birthdays, anniversaries and other celebrations. Presents can be expensive so put away some money now and your friends won't have to be disappointed with your home-made gifts.
You could even buy or layby your presents now because stores may be offering sales and discounts that aren't available in the lead up to Christmas. Not only will you get your presents for a cheaper price you can also avoid a large end of year credit card bill.
Source: Australian Securities Investment Commission (ASIC) - FIDO
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HERE'S A THOUGHT . . .
"He who has health has hope, and he who has hope has everything." ~ Arabian Proverb
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Illegal Early Access to your Super
Sometimes when you are in financial trouble it might seem like a solution to access your super, but depending on your situation, this may not be the best way to help you out of financial trouble.
Be cautious if a broker or your lender suggests accessing your super as a first step. It may save your bacon in the short term or it may just be throwing good money after bad.
By law, you generally get your super only when you:
• permanently retire from the workforce, and also
• reach the minimum age set by law, called your 'preservation age', see the following table.
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Your date of birth
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Minimum age for getting your super benefits
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After June 1964
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60
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1 July 1963 - 30 June 1964
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59
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1 July 1962 - 30 June 1963
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58
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1 July 1961 - 30 June 1962
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57
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1 July 1960 - 30 June 1961
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56
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Before 1 July 1960
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55
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You can get your super earlier only in limited circumstances:
Incapacity
Contact your fund if you suffer from a permanent incapacity. You may also be paid a 'non-commutable' income stream during a period of temporary incapacity (you won't be able to get a lump sum in the case of a temporary incapacity).
Severe Financial Hardship
Contact your fund. If the rules allow early release of benefits, you must satisfy the trustee that you have been receiving a Commonwealth income support payment for a continuous period of 26 weeks and you cannot meet your reasonable and immediate family living expenses.
Compassionate Grounds
Contact your fund. If the rules allow early release of benefits, the 'compassionate grounds' are set out in the law.
Compassionate grounds involve medical treatment for serious conditions that is not readily available through the public health system, transport for medical treatment, changes to a home or vehicle because of a severe disability, palliative care, funeral and burial expenses, or to prevent the forced sale of your home by your mortgagee. Australian Prudential Regulation Authority has more information about specific compassionate grounds.
APRA must consider your application first, before your fund trustee can make a final decision. The following APRA data shows how many applications for release of super on compassionate grounds APRA has received and approved in the past.
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Year
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Applications APRA received
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Applications approved in part or full
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Amount approved for release
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Average amount released per application
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2003/04
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11,504
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8,556
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$55,459,704
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$6,482
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2004/05
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11,653
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9,444
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$77,680,070
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$8,225
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2005/06
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15,027
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12,761
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$120,824,292
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$9,468
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2006/07
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18,245
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15,412
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$156,905,338
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$10,181
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2007/08
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19,291
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14,153
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$164,210,380
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$11,673
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Source: Australian Prudential Regulation Authority Annual Report 2008.
Terminal Medical Condition
People with a terminal illness or injury can access their benefits from their super fund tax-free. Contact your fund if you have a terminal medical condition and want to access your super, as they make the decision on whether or not to release your super.
If your super fund does allow these types of payments, you need to supply them with medical certification before they can make a payment. The payment can only be made as a super lump sum. For more information see the Australian Taxation Office website.
Leaving Australia Permanently
Contact the ATO because you may be eligible to claim your super when you permanently leave the country if you have worked in Australia as a temporary resident.
If you leave the country and haven't claimed your super at least 6 months before you leave, it will be paid to the ATO. You will then have to claim it back from the ATO and it will be repaid after normal taxes are paid.
This payment is not available for permanent Australian or New Zealand citizens because they have the option of retiring in Australia.
Small Balance
Contact your fund. If the fund rules allow it and you account has less than $200 (preserved benefit) you may be allowed to withdraw the money when you finish your employment. A fund may be able to pay you if you were previously classified as a lost member and the preserved benefit, at the time it is paid to you, is less than $200.
Unless you really need the money, it's generally better to roll it over into your next fund, and you won't have to pay tax.
Illegal Early Access
Australians are being warned to steer clear of illegal offers to release their superannuation benefits before retirement.
Avoid illegal schemes that try to get your super money out early, and save yourself from getting cheated and from heavy tax and legal penalties. These schemes are sometimes promoted by word of mouth or shady advertising.
Report to ASIC or the ATO anyone who tries to talk you into getting your preserved super benefits early for a fee.
Avoid illegal schemes deliberately target people experiencing financial difficulties. It’s understandable that people may be attracted to such promotions particularly when they are doing it tough with meeting financial commitments, such as home loan repayments.
In very limited circumstances it may be legally possible to access some of your super early, however, this should really be a last resort because it will leave you with less money in retirement. As well as the risk of losing their hard-earned super savings, victims may suffer severe tax complications as a result of the fraudulent payments involved with early release schemes.
Schemes offering early access to super are illegal and attract significant legal and financial penalties to promoters and clients. If you’re in an SMSF, you are the trustee of your fund and must operate the fund in accordance with the law. Failing to meet this obligation is, in most cases, breaking the law. If you receive an offer to access your super through an illegal scheme, contact ASIC’s Infoline on 1300 300 630 or the ATO on 13 10 20 to report your concerns.
Source: Australian Securities Investment Commission (ASIC) - FIDO
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HERE'S A THOUGHT . . .
"Do not wait; the time will never be "just right." Start where you stand, and work with whatever tools you may have at your command, and better tools will be found as you go along." ~ Napoleon Hill
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Future Proofing your Business With Succession Planning
Establishing a business succession agreement together with comprehensive insurance can help prevent future complications. Business succession agreements play an important role in ensuring that a business and its owners are protected in the event of the voluntary departure of an owner, or an unexpected event.
Consider what happened to Helen and Sarah, a couple of talented young graphic designers.
A Cautionary Tale
After graduating from university in 1998, Helen and Sarah take a big risk and establish a graphic design company together, each holding a 50% shareholding. By 2005 they are making a good living and have developed strong relationships with their customers and employees. Helen’s only concern is Sarah’s new husband, James, who is starting to interfere in the business with grandiose and inappropriate schemes. Sarah knows how Helen feels and keeps James at arm’s length.
As their business thrives, Helen and Sarah consult a financial adviser about how they can minimise their tax and invest surplus cash. Their financial adviser recommends they both draw up wills and also consider setting up a separate will for their business – in other words, a business succession agreement.
Their adviser also suggests they both take out life, total and permanent disability (TPD) and trauma insurance as part of their business succession agreement so if one of them were forced to leave the business because of an insurable condition, funds would be available to buy out that person’s share.
Both Helen and Sarah establish wills shortly after the meeting with their adviser. But as they are still young and very happy working together they decide there’s no need to establish a buy/sell agreement at this stage or take out insurance.
Tragedy Strikes
One day in 2007 Sarah collapses in the office. An ambulance is called, but the paramedics can’t revive her and she dies in front of Helen and her staff. The cause of death is later established as a brain aneurism. Helen is deeply affected by Sarah’s death, initially closing the business. After her initial grief subsides Helen decides to go back to work.
On the day of the office reopening Helen is reasonably upbeat until she meets her new business partner – James. As the sole beneficiary of Sarah’s will, James has inherited all her assets, including the 50 per cent shareholding in the graphic design company.
Over the next month, James makes Helen’s life very difficult. He insists on being involved with all business decisions, even though he has limited business acumen and no understanding of graphic design. Furthermore, one of Helen’s staff members is becoming increasingly uncomfortable around James and wants to resign.
One day while out for lunch Helen bumps into her financial adviser. She immediately remembers her adviser’s recommendation about setting up a business succession agreement, and wishes she had entered into a buy/sell agreement prior to Sarah’s death.
A business succession plan would have:
- provided Helen with a greater level of control over who will replace Sarah
· funded buying out Sarah’s share of the business via additional insurance covering events such as death, TPD or serious medical illnesses
· prevented James’ involvement in the business as he is unsuitable and cannot work constructively with Helen and her staff
· offered greater peace of mind for everyone involved in the business, including customers, suppliers and employees
Had Helen taken out the recommended insurance policies, she would have the funds readily available to exercise an option under the buy/sell agreement to buy Sarah’s shares from her estate for a set price.
This is just an example of what can happen. If you would like any information speak to your financial adviser.
Source: AXA
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This newsletter contains general information only and does not take into account the investment objectives, personal circumstances or financial needs of any particular investor. You should therefore obtain professional financial advice before making any investment decision based on the information provided in this document. In the event that this newsletter contains information about a particular financial product, you should also obtain a Product Disclosure Statement in respect of that product prior to making any decision to acquire that product.
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For more information please contact:
Brett Davis, Paul Hewins or Danielle Barber
Portfolio Managers Pty Ltd
Ph: (03) 9226 0835
Fax: (03) 9222 2019
Australian Financial Services Licence No. 232459
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