1. Active Portfolio Management
2. Succession to a SMSF
3. Do Australians Have the Right Priorities in Life?
4. Having a Baby
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Portfolio Managers'
Investor Insights
February, 2010
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Welcome to the February, 2010 edition of Investor Insights.
Please feel free to forward this newsletter to any friends or associates that may find the information beneficial.
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Over the last 50 years or so the most popular method for investing was to buy-and-hold a diversified portfolio of investments. Buy-and-hold investing works well in secular bull markets. During bull markets the principal risk is being out of the market and missing out on the capital appreciation that is available while share prices move higher.
Of course, even in secular bull markets, there are times when share prices move lower. The accepted strategy for dealing with these periods is to ignore short-term volatility and simply wait until things get better. However, over the last couple of years investors have faced a global financial crisis where virtually all risk-orientated asset classes have plunged in value. The results for many investors have been catastrophic. We have essentially been in a secular bull market from 1982 to 2007. Since late 2007, we have arguably been in a secular bear market that could last for several more years. We believe that to be in control of your own financial future it is now, more than ever, important to actively manage your investment portfolio. Although we are starting to see signs of an economic recovery, many of the causes of the global financial crisis still exist. Furthermore, the solvency of many economies is likely to be a growing issue and 2010 could be the year the global financial crisis becomes a sovereign debt crisis. We have already seen problems with Iceland, Greece, Spain, Ireland, Mexico and Dubai. In addition the UK's credit rating is under pressure, and Standard and Poor's has it on a negative outlook rating. The rating agencies have also warned the US government, and given it a four year timeframe to show attempts to improve fiscal management. The question therefore arises as to, now that the bull market has ended, how to manage risk in a bear market. Firstly I would briefly like to reiterate how we have actively managed portfolios over the last few years as well as mentioning some developments we intend introducing. Risk Management There are two basic methods for managing portfolio risk:- • Diversification; and • Valuation. Firstly, we believe that investors should diversify. But the problem with diversification is correlation, i.e. how different asset classes perform under the same market conditions. To have a well diversified portfolio investors should have investments with a low correlation to each other, so that they don’t move in the same direction at the same time. But correlations change over time and tend to rise in bear markets. Secondly, we believe that investors should avoid buying overvalued assets. The problem with valuation is that market valuation in a poor market-timing device. Markets tend to overshoot their fair values both to the upside and the downside. In addition, determining market value is a subjective process. Tactical Asset Allocation The fundamental goal of superannuation is securing your retirement income. But you don't get any closer to that goal by not addressing the issue of portfolio rebalancing. Portfolios are rebalanced to preserve or revise your original asset allocation decisions. If you fail to rebalance them regularly, you'll end up with too much of your net worth concentrated in one asset class. This potentially exposes you to added risks. The approach we adopt to rebalancing for our Portfolio Monitoring Service clients is a Tactical Asset Allocation (“TAA”) approach. Under this approach the asset allocation is not fixed but deviates from the long-term allocation to favour asset classes that have the best valuation characteristics at any point in time. TAA therefore uses both diversification as well as assessments of market values to manage risk. Technical Analysis While valuation is vital for selecting an appropriate asset allocation, in making specific share recommendations we also utilize elements of technical analysis to determine when to buy and sell. A perfect timing system does not exist but that is not to say that technical analysis is without merit. Quite to the contrary. Technical analysis plays a larger role in short-term stock market movements than fundamental analysis. Our philosophy is to buy a stock when it is going up and to sell when it is going down. The reason for this is that stocks going up in price tend to continue to go up and stocks going down in price tend to continue to go down. Stop Losses Selling is a crucial part of successful investing, but most investors avoid it like the plague. The reasons are clear. Hope of future profits is gone and losses become a reality. Tax consequences must be addressed and the proceeds need to be reinvested. Nevertheless, selling must be done and stop losses are a disciplined way of doing this. Simply put, a stop loss order is an order you place with your broker to sell your position if the share price drops below a certain level. For instance, if the share price of XYZ Ltd was trading at 90 cents, you could place a stop loss order at 80 cents. Stop losses are one of the most controversial and misunderstood methods of selling shares as they are a two edged sword. They can cut losses and protect profits or result in high turnover and lost opportunities. Holding for the long term may avoid transaction costs. More importantly, you'll be focused on long-term value over short-term trends. The trouble with this idea is that when markets are so volatile - and they're likely to be in a world with sovereign default risk - you can get sudden swings in stock markets that may not seem related to underlying company fundamentals. We therefore believe that utilising stop losses should enable you to protect profits before they shrink, and to cut losses much sooner than you may have been inclined to do in the past. Conclusion In summary, we believe that it is important to preserve your capital by active portfolio management. To some investors this may seem more like a trader's strategy. But a world of low short-term interest rates and easy money forces you to shorten your time horizon and more actively manage your investments - or risk more losses due to shifts in asset and currency markets and/or getting eaten alive by inflation. |
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HERE'S A THOUGHT . . .
"To climb steep hills requires slow pace at first." ~ Shakespeare, Henry VIII
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A key planning element for covering risks on death or incapacity is to have a trusted person stand in as your successor trustee/director.
This requires planning in advance to ensure the smooth transition to a self managed superannuation fund. To ensure that this occurs, amongst other things, the following needs to be undertaken. Selection Select the person who is to become trustee/director. Ensure they are willing to act and there are sufficient instructions/wishes documented for them on what needs to be done. Deed Check the SMSF deed and, if a corporate trustee is in place, the constitution to see what steps and documents need completing to appoint that person. Typically, in addition to that person consenting in writing, they may need to satisfy some other hurdles and better to discover these now; otherwise it may be too late. Voting Mechanism In so checking the deed/constitution it is important to check what voting mechanism applies, eg, are decisions determined by the number of trustees/directors, member account balances, shares held in the corporate trustee or via some other method. This is important as it may need amending if it is not appropriate. For example, if the relevant member has the lion’s share of the fund, and voting is based on the number of trustees/directors, then this could give rise to an unnecessary deadlock. One mechanism to work through this type of deadlock would be to give the person with the majority account balance a casting vote by tailoring the documents accordingly. Nominating Appropriate Person Make sure the person’s Will and enduring power of attorney (‘EPoA’) nominate the appropriate person that they wish to stand in their shoes. Note, the ATO in SMSFR 2008/D1 consider that a member can only nominate one attorney or legal personal representative (‘LPR’) to stand in their (trustee) shoes. Thus, if there are more than one attorney/LPR, the nomination should specify who has first go and it is also advisable to specify one or two substitutes who can also step in should the member’s first choice be unavailable or refuses to act, etc; this is similar to nominating executors in a will as the chosen executor may not wish to act. Also, a nominated SMSF trustee/director could be disqualified if they are bankrupt or if they have ever been convicted of an offence involving dishonesty. More than one Attorney or Executor It is important to note that if someone has more than one attorney or executor and they wish to nominate more than one (despite the ATO’s current view in SMSFR 2008/D1), that the voting and decision provisions of the relevant SMSF deed and constitution should be carefully examined. This is because unless there are special provisions to equalise voting, each attorney/executor will have equal control. However, the attorney/executor who is standing in for the incapacitated/deceased member should only assume this (one) person voting capacity. Thus, if there are two attorney/executors nominated to act jointly, the joint attorney/executors should only have the equivalent of one vote. Constitution In the case of a corporate trustee, the decision making depends in the first instance on what’s in the constitution (and not the deed). In most constitutions directors usually have an equal vote regardless of the number of shares they hold or their account balance in the Fund. The casting or deciding vote is generally given to the chairperson of the meeting. Given, that most mum and dad companies do not comply with formalities, there is generally no practical mechanism to work through potential deadlocks. One solution could be, for instance, if there is a deadlock the person with the most voting shares can have a casting vote. Again, the constitution could be tailored to provide such a mechanism. Corporate Trustee There are numerous advantages for using a corporate trustee compared to individuals as trustees. However, if the SMSF deed provides the majority of members may hire and fire the trustee, then the company could be removed. Thus even if a corporate trustee is used, it is worthwhile checking the mechanism for changing a trustee to ensure a smooth and planned succession can occur. For example, if you have nominated someone to become appointed as trustee/director, then this person could be voted out soon afterwards if the deed or constitution allows this by say empowering the other trustees/directors to carry a majority vote. Successor Shareholder Where a corporate trustee is used, it is also important to consider who will be the successor shareholder as the shareholders generally hire and fire the directors. Thus succession involves a review of both the SMSF deed and the constitution and these two need to be consistent in design and the implementation of the succession strategy to overcome conflicts arising. Source: DBA Lawyers
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HERE'S A THOUGHT . . .
"Worrying is like a rocking chair: it gives you something to do, but it doesn't get you anywhere." ~ Unknown
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Life is about enjoying the things that matter to you most. Most employed people have some life insurance through their super, however, research has consistently shown that the level of cover leaves many exposed to the risk of financial hardship in the event of accident, sickness or death.
Why is this a problem? More than three in four Australians will be diagnosed with a serious illness in their working life. The majority will rely on savings, selling assets in an uncertain property market or government welfare. And a significant proportion of Australians would face financial hardship if they were to have an accident, become sick or die. While most insure their home and would never consider driving a car without motor insurance, less than a third of Australians insure their most important asset, their income. Australia is one of the most underinsured nations in the developed world ranking 16 for life insurance density and penetration. Even so, life insurance companies pay out almost $10 million every working day in claims to customers. This figure would be significantly higher if Australians had adequate levels of cover. Research has consistently shown Australians don’t take out adequate levels of insurance to protect themselves and their family. In fact, research commissioned recently by IFSA found that only four per cent of the total population with dependent children have adequate levels of life insurance cover. And, 60 per cent of families with dependent children do not have enough insurance to cover the household expenses for a year if the family breadwinner were to die. The Victorian bushfires in February 2009 highlighted just how important it is to have enough cover in place. 173 people died, 78 communities were devastated, 2000 homes and businesses destroyed, and 400,000 hectares were burnt to cinders. While 27 per cent of property was uninsured only one in five of the people who lost their lives had life cover. Around 143 people, or over 80 per cent of the victims did not have basic life insurance policies in place. Many of those who were covered had insufficient sums insured to support their families financially in the aftermath. Life insurance provides the financial support for people through their most difficult times. During most people's lifetime there's a pretty good chance that they are going to need a hand at some stage. It's worthwhile reinforcing what life insurance cover can provide. • Life insurance enables you to continue to make mortgage, rent and other living, medical or recovery expenses and can help to pay off debt. This empowers you to continue everyday things, such as spending precious time with your family and enjoying the other things you love. • It provides you with sufficient funds to be in control during difficult times and the freedom to choose treatment and lifestyle options at that time. • suffering from a serious illness or overcoming the death of a family member can be made even more stressful when you are struggling to meet financial commitments. Life insurance can reduce your stress so you can focus on your emotional or physical recovery. It is wise to review your insurance needs as and when your circumstances change. For example, on taking out a mortgage, getting married, starting a family or building a business. No matter what your circumstances are, life insurance helps preserve your freedom to enjoy the life you want for yourself and your family. It's a fact that many people are affected by unexpected illness or injury during their life. The statistics listed below help highlight these risks The Facts of Life • 50,000 Australians have heart attacks every year. • One third of women and a quarter of all men will suffer cancer at some stage in their lifetime – over half of whom will live for longer than five years after diagnosis. • More than 42,000 people are expected to die from cancer in 2009. • Half of all men and a third of women will be diagnosed with cancer before the age of 85. • Over 1600 people die on Australian roads every year, most aged 26 - 59 years. • One stroke event occurs in Australia every 12 minutes. • Just under half the population with an arthritis-associated disability are aged 15-64. • With symptoms generally developing between ages 20-40, multiple sclerosis is the most common chronic central nervous system condition among young Australian adults. Source: Zurich Life
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HERE'S A THOUGHT . . .
"Only those who will risk going too far can possibly find out how far one can go." ~ T S Elliot
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Having children can be a wonderful experience. But it's also very expensive. Have you thought about how you will cover the extra costs on a reduced income? The best way to plan for your family's future is to make a budget and think about the following:
The Cost of Having a Baby Costs of having a baby can include: the possibility of needing a bigger home; nursery furniture, high chairs and strollers; childcare; baby food and skincare products; disposable nappies and baby clothes. It's important you plan your finances as much as possible to cover these and other costs because it is likely you will be on a reduced income. Managing on a Reduced Income Whether you are a couple having children or becoming a single parent on your own, having children will have a major impact on your finances. One change you'll need to adjust to will be the loss of income of the main carer, as most mothers take some time out of the workforce when a child is born. If you are employed, find out if you have access to paid maternity leave (or other parental leave entitlements as a condition of your employment), to help you plan the length of time you will be off work. And check whether you are eligible for any government payments. You will need to plan how to meet your everyday living expenses, plus new expenses. Portfolio Managers has a cashflow service which can enable you to manage your money. Remember to include expenses you don’t currently have. Your Superannuation Super contributions paid by your employer on your behalf will cease if your salary or wages payments do. Remember to allow for anticipated periods out of the workforce when you plan your long-term super goals. If it's possible, talk to your spouse about them contributing to your super. This can have tax benefits. Contact Portfolio Managers to tell you more. If you hold life or disability insurance cover through your super fund, check whether it will continue if your employer stops making super contributions. |
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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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