Private Wealth vol10 no01 by financial.standard

The Journal of Family Office Investment

Volume 10 Issue 01

Transitioning the family business EY

Intangible assets Dimensional

THE WELLNESS MILLIONAIRE Radek Sali, Light Warrior

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Charity and cy-pres Investing in esports Shareholder disputes

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Contents

www.fsprivatewealth.com.au Volume 10 Issue 01 | 2021

COVER STORY

THE WELLNESS MILLIONAIRE Radek Sali Light Warrior

16 VANTAGE

POINT

The Reserve Bank of Australia’s first monetary policy meeting for the year painted a tale of two countries. The first is an Australia where GDP has performed better than expected. The second is a place where spare capacity in the economy means rates must remain low, Financial Standard chief economist Benjamin Ong writes.

HIGHLIGHTS Welcome note Christopher Page

05 IN THIS ISSUE HOUSING MARKET SENTIMENT PERKS UP

Australians’ sentiment for residential property has improved, with positive views being the highest since 2019 in ME Bank’s quarterly barometer.

US UNEMPLOYMENT SHOWS IMPROVEMENT

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United States’ unemployment rate ticked down from 6.7% to 6.3% in the month of January. But, the country still has 10 million less jobs than in February 2020.

INDONESIAN GDP

Featurette Testamentary trusts

For the full-year 2020, Indonesia’s economy shrank by 2.1% – the first full-year contraction since the 1998 Asian financial crisis.

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Contents

www.fsprivatewealth.com.au Volume 10 Issue 01 | 2021

CAN MONEY BUY HAPPINESS? Christopher Page, managing director, Financial Standard The jury is still out on if money can buy happiness. But, they’ve returned from this round of deliberation with a different conclusion than last time – which is that annual income does positively affect wellbeing.

Published by a Rainmaker Information company. A: Level 7, 55 Clarence Street, Sydney, NSW, 2000, Australia T: +61 2 8234 7500 F: +61 2 8234 7599 W: www.financialstandard.com.au Associate Editor

Samantha Sherry samantha.sherry@financialstandard.com.au Graphic Designer Jessica Beaver jessica.beaver@financialstandard.com.au Technical Services Roger Marshman roger.marshman@rainmaker.com.au Advertising Stephanie Antonis stephanie.antonis@financialstandard.com.au Director of Media and Publishing Michelle Baltazar michelle.baltazar@financialstandard.com.au Managing Director Christopher Page christopher.page@financialstandard.com.au

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The Journal of Family Office Investment ISSN 2200-4971

News

ASIC WARNS OF BOND FUND SCAMS THE POLITICS OF INVESTING IN S&P 500 ADVICE FIRM HIRES SYDNEY UNIVERSITY CIO

Kanika Sood kanika.sood@financialstandard.com.au Production Manager

Welcome note

News

FUTURE FUND UPS CASH AGAIN CITI COMBINES GLOBAL WEALTH BUSINESS LOUISE WALSH LEAVES FUTURE GENERATION

10 16

All editorial is copyright and may not be reproduced without consent. Opinions expressed in FS Private Wealth are not necessarily those of Financial Standard or Rainmaker Information. Financial Standard is a Rainmaker Information company.

News

BILLIONAIRE WEALTH SWELLS IN COVID SMORGON FAMILY IN WILL STOUSH

News

CHARITY REPORTING RULES RELAXED THE WORLD IS READY FOR ESG

Cover story

THE WELLNESS MILLIONAIRE Radek Sali, Light Warrior The former Swisse boss shares how his family office picks its investments, and the opportunities it sees in 2021.

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Wednesday 5 May 2021 8:30am to 3:00pm Four Seasons Hotel 199 George Street Sydney NSW 2000

EXCHANGE TRADED PRODUCTS This CPD-accredited event seeks to inform advisers and investment professionals about the benefits of using ETPs, including Listed Investment Companies, Listed Investment Trusts, mFunds, Exchange Traded Funds (ETFs) and Active ETFs. The appeal of ETPs has continued over the last year, with FUM sitting at $150 billion after record growth, as at 28 February 2021. The forum will explore how this evolving industry is answering the needs of today’s financial planning and wealth management community. Visit financialstandard.com.au/etp_forum or call 1300 884 434

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Contents

www.fsprivatewealth.com.au Volume 10 Issue 01 | 2021

WHITE PAPERS Family Office Management

TRANSITION CHOICES WHEN YOUR BUSINESS IS PART OF THE FAMILY By Steven Shultz, EY Hit HBO series Succession follows the Roy family as its patriarch readies to step back from his media empire. Transitions in real life can be equally challenging, writes the author.

Investment

INVESTING IN ESPORTS AND VIDEO GAMES By VanEck Esports is a bigger industry than both cybersecurity and robotics, yet has failed to garner the same level of attention from investors. VanEck shares its case for investing in the asset class.

ADDRESSING HOUSING AFFORDABILITY IN AUSTRALIA By Matthew Tominc, Conscious Investment Management On any given night in Australia, 4.2% of households need to rent social housing. This whitepaper looks at the supply and demand in the segment and considers solutions.

TRUST AND UNDERSTANDING IN BUSINESS-OWNING FAMILIES By Barclays Private Bank Barclays conducted 402 interviews with three generations of wealthy families and 20 with private bankers and intermediaries. Here it shares how they think about multi-generational wealth.

Taxation & Estate Planning

LEAVING A GIFT TO A CHARITY THAT NO LONGER EXISTS By Geoff Milani, Elringtons Lawyers This whitepaper explains the use of cy-pres in cases where a deceased’s bequest to a charity can’t be honoured anymore.

56 40 Investment

Family Office Management

Compliance

RESOLVING AND PREVENTING SHAREHOLDER DISPUTES By Kayleigh Yap, Sprintlaw Out-of-court negotiation is the best way to go when you can’t see eye-to-eye with another shareholder in a business venture. But it doesn’t hurt to know the legal modus operandi.

Ethics & Governance

RISKY BOARD BUSINESS By Omer Soker, Association Impossible The author shares top water cooler grievances that chief executives have about risky board behaviour, and how to navigate them.

Investment

INTANGIBLE ASSETS: WHAT’S EASY VS WHAT’S RIGHT By Savina Rizova, Dimensional How should value investors think about valuing a company’s intangible assets? This whitepaper shares a framework.

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Investment

INVESTMENT IDEAS FOR THE NEXT 12 MONTHS By Yoram Lustig and Michael Walsh, T. Rowe Price This paper identifies five key themes that could drive economic and market performance over the coming 12 months and beyond.

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Welcome note

www.fsprivatewealth.com.au Volume 10 Issue 01 | 2021

Christopher Page managing director Financial Standard

Can money buy happiness? again, the age-old question is back in the spotOThisnce light. time, new research (pg.7) says emotional wellbeing does in fact increase with a person’s annual income. That’s the opposite of what Nobel Prize winning economist Daniel Kahneman’s 2010 study found – that after about US $75,000 a year, money stops buying happiness. For me, the new results bring mixed feelings. More money means more options but maybe also more stress. But if money and wellbeing are positively correlated, it’s all the more reason for us to pay greater attention to how we invest our family wealth. For our first cover story for the year, we wanted to bring you an Australian who has been proactive in doing this. And we found a fitting but unlikely subject in former Swisse chief executive Radek Sali (pg.16). ‘Fitting’ because Sali has run a single family office, called Light Warrior, for about six years now, staffing it with top talent and investing heavily outside of the traditional managed fund route. ‘Unlikely’ because he started it when he was still in his 30s.

Sali talks in depth on how Light Warrior invests, his take on investment themes, and the family office investors he looks up to. The chat is a good warm up for the year ahead. 2021 has already thrown us many challenges. Investors witnessed the power of organised action from retail investors in the GameStop short episode. They also had to grapple with Bitcoin’s rally and another cryptocurrency Dogecoin’s ascent after effusive Twitter support from Elon Musk. The Reserve Bank of Australia extended its reign of low interest rates and came back to buy $100 billion worth of bonds (pg.7 and 22). On the brighter side, the ASX-listed companies cruised through the February earnings season. The government stripped away some red tape for smaller charities. Buyers returned in droves to the property market. Inflation ticked up slightly. There are many unknowns from where we stand. Are current levels of high asset prices sustainable? Will we see the much-predicted spike in insolvencies as government starts to turn off COVID-19 support? Our publications will be tracking the events. fs

The quote

There are many unknowns from where we stand.

Christopher Page managing director, Financial Standard

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News

www.fsprivatewealth.com.au Volume 10 Issue 01 | 2021

Watch out for bond fund scams: ASIC Annabelle Dickson

T Sydney Uni CIO joins wealth firm The University of Sydney’s chief investment officer Miles Collins has joined a dealer group as the chair of its investment committee. Collins added the role effective January 2021. Collins joined The University of Sydney’s investment and capital management team in 2016. Before this, he spent eight years as the head of investment at Myer Family Company. “Miles brings a wealth of investment experience to Walker Lane and his appointment completes a core component of the Walker Lane Value Proposition,” Walker Lane director Joshua Cratchley said. “Miles’ expertise and proven track record in the investment space provides Walker Lane with a capability to help the business achieve its growth aspirations, and our advisers look forward to working with him.” Walker Lane is a Sydney-based boutique financial advisory and investment management firm. It is owned by advisers and staff. In a similar move, WA Super’s former chief investment officer Chris West and two others started a new investment consultancy, after the fund’s merger with Aware Super. Context Capital offers investment advice to advice businesses, wealth firms and family offices, and had $1 billion in assets across four clients at 7 December 2020. fs

The quote

If you see or receive offers of high yield bonds, they are either high-risk or they may simply be bogus and a scam.

he corporate regulator is warning investors of scam bond funds targeting Australian investors with claims of high yield. The scammers are claiming to be from reputable domestic and international financial firms when there is no underlying investment at all. The Australian Securities and Investments Commission (ASIC) believes the scam occurs in most cases after an investor completes an expression of interest form via a third party or a fake investment comparison website. IFM Investors and Citi Australia had fake prospectuses for bond funds circulated in their names, the Australian Financial Review reported. ASIC did not name specific firms. Some of the scammers have been sending victims professional looking fake prospectuses with unrealistically high returns and falsely claiming investor funds will be pooled to invest in government bonds or the bonds of companies

with AAA credit ratings, ASIC said. In addition, further tactics include claiming the price of the bonds is protected under the Commonwealth Government Financial Claims Scheme and using contact details obtained online to contact people and pressure them to invest. ASIC acting chair Karen Chester urged investors to be wary of the high yield claims given interest rates are low. “If you see or receive offers of high yield bonds, they are either high-risk or they may simply be bogus and a scam,” Chester said. “Investors searching for incomegenerating investments are at risk of being duped into buying these imposter bonds. Any prospectus offering incredible returns in the today’s economic environment is likely to be just that: incredible.” Chester warned investors to ensure they check the details of the company are correct before sharing personal information. fs

You can’t hate Trump but love the S&P 500 Kanika Sood

If you disliked Donald Trump, you may want to reconsider your investment in S&P 500 stocks, as new research shows these companies are likely to donate more to the Republicans than to the Democrats. Goods Unite Us mapped political donations from S&P 500 companies to political parties and found 54% of them donated more to the Republican Party than to the Democratic Party. Meanwhile, only 29% of S&P 500 stocks gave more to the Democrats. The above is true for popular broad-market ETFs like iShares’ IVV and State Street’s SPY, which track the index. Both are listed on the ASX and available to local investors with $3.6 billion and $56 million of local money at December end. IVV is popular among SMSF investors, figuring among the second-most used ETF by the cohort in past CommSec research. “We also calculated IVV’s politics using the fund’s company weightings. Using that approach, we estimate

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that a $10,000 investment into IVV would effectively buy about $3800 dollars-worth of stock in Republican companies,” Goods Unite Us chief executive officer Abigail Wuest said in an emailed statement. The firm estimates that IVV – or other S&P 500 ETFs – companies and their senior executives have donated over US$1 billion to politicians and PACs in the last four US federal election cycles. And most of the companies in index funds like IVV and SPY make political contributions to the Republicans. However, if investors are hungry for politicallyaligned investment products is still open to question. In September 2017, Point Bridge Capital launched a Republican-themed ETF with the ticker MAGA (for Trump’s ‘Make America Great Again’ slogan). As of January 26, this ETF had only gathered about US$10 million in assets. A Democratic-themed ETF, called the Democratic Political Contributions ETF (DEMZ) was launched in February 2020 and as of January 28, had about US$2.3 million in total assets. fs

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News

www.fsprivatewealth.com.au Volume 10 Issue 01 | 2021

RBA says to expect low rates until 2024

Australia’s largest donors

Kanika Sood

Karren Vergara

An analysis by Strive Philanthropy found the largest ASX-listed companies pledged $1.1 billion to philanthropic efforts in 2020, which is 17% more than the prior year. Thirty firms donated over $175 million to COVID-19 relief efforts, typically viral research and local communities, the 2020 GivingLarge Report found. Mining companies BHP, Rio, Newcrest and South32 contributed a combined $100 million. Macquarie Group gave $20 million via its foundation, while Woodside Energy set up a $10 million COVID-19 community fund. As for the devasting bushfires that wreaked havoc in 2019-20, some 113 companies gave $145 million in total. The big four banks made a combined $19 million donation for bushfire appeals. News Corp and Seven Group donated $5 million each. The report calculated how much the donations represented as a percentage of the company’s pre-tax profit. Coles came out on top, donating $125 million in 2020 or 7.3% of its profit on a rolling three-year basis. Commonwealth Bank led the pack among the banks, donating $70 million or 0.7% of its profit. BHP gave the largest dollar value in the list at $221 million. Strive Philanthropy founder Jarrod Miles said the spike in giving in 2020 is warmly welcomed but won’t be enough. “Sustainable philanthropy is about a change in thinking, not just the rise in dollar donations. The good news of 2020 is that this change of thinking seems to be hardening and we can only hope will propel corporate philanthropy nicely into the decade,” Miles said. fs

FS Private Wealth

The numbers

900,000 Australians currently unemployed. This is 220,000 more than before the pandemic.

he Reserve Bank of Australia’s (RBA) February policy statement told Australians to expect low rates until at least 2024, as actual inflation stays outside its 2% to 3% target range. It also launched an additional $100 billion of government bond purchases, commencing in mid-April and running at $5 billion a month. Gross domestic product (GDP) contracted by 2% in 2020, which was lower than previously expected. It expects growth to be around 3.5% over 2021 and 2022 each as the economy recovers. Unemployment fell to 6.6% in December, which also was better than expected. Participation is back to pre-pandemic highs. Yet, 900,000 Australians are unemployed, which is 220,000 more than the pandemic. The RBA said unemployment has likely already peaked, and will fall to 6% by 2021 end, 5.5% by 2022 and 5.25% by mid-2023. “Underlying inflation pressures remain subdued and are expected to be fairly muted in the period ahead.

Spare capacity in the labour market remains elevated, and wages growth has eased further from already low rates,” the RBA said in its February statement on monetary policy. “Many employers have responded to the economic challenges of the pandemic by delaying wage increases, imposing wage freezes and, in some cases, applying temporary wage cuts. Forward indicators suggest wages growth will remain soft this year,” it said. The RBA concluded that while growth and unemployment looked better than before, inflation and wage growth were likely to be subdued. It said significant gains in employment and a return to a tight labour market were needed to improve wage growth and in turn higher inflation as well as rates. “The recovery is likely to be bumpy and uneven, and dependent both on the health situation and ongoing fiscal and monetary policy support. Spare capacity will remain for some years, dampening inflationary pressures.” the RBA said. fs

Turns out money can buy happiness Eliza Bavin

Contrary to popular belief, money does buy happiness, says new research. A study conducted by Proceedings of the National Academy of Sciences (PNAS) in the US found that while personal wellbeing does not increase above incomes of US$75,000, emotional experience does. The study traced over a million real-time reports of experienced wellbeing from a large US sample, collected via a mobile application. It found evidence that people’s experienced wellbeing increased with income, with an equally steep slope above US$80,000 as below it. “Drawing on 1,725,994 experience-sampling reports from 33,391 employed US adults, the present results show that both experienced and evaluative wellbeing increased linearly with log (income), with an equally steep slope for higher earners as for lower earners,” wrote Matthew Killingsworth, who is a senior fellow at Wharton

School for Business at the University of Pennsylvania. “There was no evidence for an experienced wellbeing plateau above $75,000, contrary to some influential past research.” The research also said there was also no evidence of an income threshold where experienced and evaluative wellbeing diverged, suggesting that higher incomes are associated with both feeling better dayto-day and being more satisfied with life overall. “While there may be some point beyond which money loses its power to improve wellbeing, the current results suggest that point may lie higher than previously thought.” This is a contrast to Daniel Kahneman and Angus Deaton’s 2010 study, which has shaped the money versus happiness debate in the recent years. The duo said a person’s emotional wellbeing stops rising with their annual income once they hit the US $75,000 mark. fs

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News

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Louise Walsh leaves Future Generation

Future Fund increases cash again

Future Generation companies’ chief executive Louise Walsh will leave after six years and look for a new role. Walsh will step down from the role in April. Wilson Asset Management chief executive Kate Thorley, who is also a director at Future Generation Investment Company (FGX), will act as the chief executive of both FGX and Future Generation Global Investment Company (FGG) until a permanent replacement is found. “On behalf of Future Generation’s 29 pro bono fund managers, 15,000 shareholders, 20 charity partners and the countless young Australians they support, we thank and congratulate Louise for her outstanding contributions to both companies,” said FGX and FGG founder and director Geoff Wilson, FGX chair Jonathan Trollip and FGG chair Belinda Hutchinson. Walsh said she had served three-months’ notice and was looking for a new role. “For the next role, I’d love to work with an exciting, creative entrepreneur like a Geoff Wilson,” Walsh told Financial Standard. “In any career you like to leave on a bit of a high note and the companies are in good space…I am 55 and I feel like there is another big role left in me – or two. You can’t look for that role when you are currently at a public company.” FGG has forgone $69.6 million in annualised fees since inception, and returned 1.9% better than its benchmark over the period. Caledonia, Magellan and Cooper Investors together manage about a third of the LIC’s assets. fs

Kanika Sood

The quote

It [may] look like we are more defensive but that’s not the case.

he $171 billion sovereign wealth fund increased its cash position to 19.8% or about $34 billion, as it reported a positive year ending December. Future Fund returned 1.7% in the year, after positive returns in the September and December quarters lifted it back to the positive territory from FY20’s negative returns. The 1.7% return for 2020 is still below the target return of 4.4%, which is set at CPI plus 4% to 5% over the long-term. It is also a sharp contrast to 2019’s pre-COVID returns of 14.3%. Longer-term returns (three-years and beyond) remain above the target. Future Fund chief executive Raphael Arndt said the remarkable changes in policy, economies and markets are changing the investment landscape. “While markets have performed strongly, we remain conscious of the potential downside risks, including from public health and economic reversals and so the portfolio is positioned at around neutral levels of risk,” Arndt said. FY20 was the second time in Future Fund’s 15-year-long history that the main fund returned a negative return

(-0.9%). The last time this happened was in FY09 when it returned -5.1%. In 2020, Future Fund returned -3.4% in March quarter, -0.7% in June quarter, 1.1% in September quarter and 4.9% in December quarter. The main fund increased its cash position throughout 2020. At March end last year, it had 9.6% of its assets in cash. This was increased to 17% at June end, and finally to 19.8% at December end. “It [may] look like we are more defensive but that’s not the case. We are more flexible and keen to preserve the robustness of the portfolio...” Future Fund chief investment officer Sue Brake said. Asset allocation at December end stood at: 7% or $11.9 billion in Australian equities, 16.8% or $28.6 billion in developed global equities and 8.3% or $14.2 billion in emerging markets equities. In other asset classes it had 13.4% or $23 billion in private equity, 6.1% or $10.4 billion in property, 7.4% or $12.7 billion in infrastructure and timberland, 7.1% or $12 billion in debt securities, 14.2% or $24.2 billion in alternatives and 19.8% or $33.8 billion in cash. fs

Citi unifies global wealth management Elizabeth McArthur

Citi has overhauled its wealth management business, bringing together its global consumer banking and institutional client operations. Citi Global Wealth will be led by Jim O’Donnell. The institutional clients group looks after more than 1000 clients across Australia and New Zealand, including across custody, trading and banking. The new business will also incorporate Citi Private Bank and Citi Personal Wealth Management. O’Donnell will report to Anand Selva, chief executive of global consumer banking and Paco Ybarra, chief executive of the institutional clients group. Prior to this appointment, O’Donnell was global

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head of investor sales and relationship management. “Creating a unified Wealth organisation will help us to deliver the full, global power of Citi to clients while ensuring that we preserve the products, capabilities and expertise of the Private Bank and Consumer Wealth businesses,” he said. Citi chief executive Michael Corbat and Citi president and incoming chief executive Jane Fraser said in a joint statement: “Making wealth management a key differentiator and source of enhanced returns for Citi will be a key element of our strategy going forward, and putting the full force of our firm behind an offering in this way is indicative of the approach we’re taking to transforming our bank.” fs

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News

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Billionaires profit from pandemic: Report

Foreign investors face tip-offs

Karren Vergara

Annabelle Dickson

The government has released a new compliance campaign to crack down on foreign investors unlawfully purchasing residential property. The tip-off campaign encourages people to send information to the tax office about foreign investors who may be breaking the foreign investment rules or suspected illegal behaviour around the ownership of residential real estate. Foreign investors wanting to purchase new dwellings, vacant residential land and in some circumstances, established property, must generally apply for foreign investment approval. Treasurer Josh Frydenberg said that while the majority of foreign investors comply with the law, Australians expect the government to maintain a high level of enforcement. “Australia welcomes foreign investment for the significant benefits it provides but the government will continue to ensure that all Australians can have confidence that their interests are being protected when it comes to foreign investment rules for residential real estate,” he said. The campaign follows legislation that introduces higher infringement notice penalties for residential land valued over $5 million to support more effective enforcement, as well as new civil penalties and infringement notices for providing false or misleading information. For those breaching the foreign investment rules, penalties including large fines or imprisonment of up to three years may apply. Lower penalties may apply for those coming forward voluntarily. Tipsters can complete an online tip-off form or call the Australian Taxation Office hotline. fs

FS Private Wealth

The numbers

$85bn

How much Australia’s richest added to their wealth in COVID-19.

he nation’s wealthiest saw their fortunes increase by nearly $85 billion during the COVID-19 pandemic, a global survey highlighting the widening income-inequity gap shows. Thirty-one Australian billionaires saw their bank balances swell between March and December 2020 in Oxfam’s latest report The Inequality Virus. The majority of the 295 economists from around the world canvased in the survey predict the pandemic will fuel income inequality in their respective countries. The four Australian economists who took part in the survey agreed that the coronavirus crisis would lead to an “increase or major increase” in income inequality. They believe the government didn’t have an adequate plan to address the issue as the gap is impacting women and ethnic minorities most.

Oxfam Australia chief executive Lyn Morgain said as hundreds of thousands of people were losing their jobs and entering an unstable employment market, a small group of elite Australians saw their incomes recover very quickly. She said the reduction of JobSeeker payments, a lifeline for millions of Australians thrown into unemployment, was “devastating”. She said this has left 1.4 million people living on about $51 a day. Overall, Oxfam found 1000 of the world’s richest recouped their COVID-19 losses within nine months. The world’s 10 richest billionaires have collectively seen their wealth increase by US$540 billion over the period. Tesla’s Elon Musk increased his net wealth by US$128.9 billion, while Amazon’s Jeff Bezos saw his fortune go up US$78.2 billion. fs

Smorgon family in Will dispute over IVF Elizabeth McArthur

One of Australia’s richest families is locked in a legal dispute over their father’s Will, which left out a child conceived by artificial insemination. The case raises the question – are children born by sperm donors or artificial insemination treated differently under the law when it comes to inheritance? Samantha Smorgon is disputing her father, Robert Smorgon’s Will which defined her as a step-child because she was conceived through artificial insemination. She was born to Robert Smorgon’s first wife. Robert Smorgon died in September 2019. It is thought that the Smorgon family fortune is in the realm of $2 billion or even $3 billion, including Smorgon Steel and other interests. Samantha Smorgon’s affidavit says she is disputing $710,000 plus property and other investments in her father’s Will. Specifically, she argues several trusts set up to benefit the Smorgon family should be benefiting her too. But, the fact that the Will defines her as a step-child and the marriage between Robert Smorgon and her mother ended could mean Samantha Smorgon has very few rights under the law.

Peter Townsend, owner of Townsends Business and Corporate Lawyers, said that in most states in Australia step-children lose their legal status as a person’s child and any claims to an estate once a marriage is dissolved. Under most state’s laws, it doesn’t really matter if the child considers the step-parent a parent long after the marriage to their biological parent dissolves, or if the step-child knew the step-parent for as long as they can remember. Once the marriage is over, the status as step-child is gone too in the eyes of the law. “The question of whether they are a step-child or not is based in law,” he said. “A step-child ceases to be a step-child when the marriage dissolves, which is something a lot of people don’t appreciate.” Things become even more complicated when the issues of sperm donors and artificial insemination are introduced. However, if the artificial insemination happened while the couple was married then whether the child shares genetic material with the father or not, Townsend said, the law recognises the child. A hearing for the matter is scheduled for February next year. fs

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www.fsprivatewealth.com.au Volume 10 Issue 01 | 2021

Charity reporting relaxed

Tide turns in ETFs, managed funds flows

About 5000 charities will see easier financial reporting requirements from mid-2021, as the Federal Treasury amends the rules. The Council on Federal Financial Relations (CFFR) has agreed to develop a framework by mid-2021 to lift the reporting threshold for small to medium charities, Treasurer Josh Frydenberg announced. This means about 3000 charities will no longer have to produce reviewed financial statements, which Treasury says costs them about $2400 each year in accounting expenses; and about 2000 charities won’t have to produce audited annual financial statements, which Treasury pegs at costing individual charities about $3000 each year. They will still have to publish an annual information sheet. The relaxation of reporting thresholds for smaller charities was recommended by a 2018 review of the charity regulator Australian Charities and Not-forProfits Commission’s legislation. It said the regulatory burden on charities should be reduced while retaining transparency and trust. “The reforms will simplify financial reporting requirements and maintain transparency to ensure charities can dedicate more of their time and resources to assist vulnerable communities,” Treasury said. “Inconsistent and outdated regulations across jurisdictions create an estimated regulatory burden of $13.3 million a year for the charitable fundraising sector. The recent Royal Commission into National Natural Disaster Arrangements highlighted the crucial role charities play in disaster recovery efforts but noted the complexities of operating across jurisdictions with distinct regulatory schemes.” fs

Kanika Sood

The quote

In the space of six or 12 months, investors have gone from thinking about ESG as a side issue to thinking about it as completely core to the future of their funds.

S exchange-traded funds ended 2020 with a new record for inflows, while managed funds set a record of their own – in highest outflows for a calendar year. Mutual funds are still roughly three times the size of ETFs in the United States, Morningstar said. But when it comes to 2020 flows, there was a stark contrast in the two fund types. ETFs set a new record for the calendar year, raking in US$502 billion in inflows. Meanwhile, mutual funds in the region saw record outflows of US$289 billion. Overall, 2020 was a bleak year for US funds management industry in capital raising. Long-term mutual funds and ETFs gathered only US$212 billion, which is much lower than the average annual inflows of US$356 billion between 2010 and 2019.

By manager, Vanguard topped the inflows with US$141 billion in the year, while Dimensional Fund Advisors had it worst with US$37 billion of outflows. By asset class, taxable-bond funds had a record year (US$441 billion in inflows) and so did commodities (US$37.6 billion in inflows). But equities funds were in outflows. “The Federal Reserve bought high-yield and corporate bond funds midyear to support the fixed-income market, and its actions helped both categories garner record inflows in 2020 of US$54 billion and US$52 billion, respectively,” Morningstar said. “US equity funds’ $241 billion of outflows for the year was four times the previous record of $58 billion set in 2015. Large-growth equity funds had $66 billion of outflows in 2020, marking their 17th consecutive year of outflows.” fs

Big year for ESG ahead: MSCI survey Eliza Bavin

MSCI phoned 200 executives at asset owners around the world and found 73% plan on upping their ESG investments in 2021. The executives, who were surveyed by phone late last year, represented sovereign wealth funds, insurers, endowments/foundations and pension funds. All together they manage around US$18 trillion in assets. An overwhelming majority (73%) said they plan to increase ESG investment either significantly or moderately by the end of 2021. “The move towards incorporating ESG considerations into investment decisions accelerated due to the pandemic, transitioning from a side-fund to a main-fund issue,” MSCI said. “As a result, more investors are putting greater emphasis on the “S” (social) in ESG. Progress on ESG is held back, though, by concerns over fiduciary duty, perceived issues with data, cost and manager inexperience.” Around 79% of those surveyed said they use climate data to manage risk in their investments. “A revolution in data usage is seen as a solution to

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many problems, from regulation to increased public pressure for transparency,” the survey said. “At the heart of this revolution is climate data, already widely used defensively to manage risk. Using climate data in an effort to boost returns is less common.” The survey found investors with over US$200 billion are four times more likely to regularly use climate data to identify investment opportunities than those with less than US$25 billion. On the internal culture side, the survey revealed diversity is among a top priority for many large firms. Of the 200 executives surveyed, just one said internal staff diversity was unimportant, however investors still feel there is room to grow with 86% agreeing that ‘more needs to be done’ or ‘there’s a long way to go’. “In the space of six or 12 months, investors have gone from thinking about ESG as a side issue to thinking about it as completely core to the future of their funds,” MSCI adviser Roger Urwin said. “It is a big shift. And in my career, I haven’t seen a shift quite like it.” fs

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Fundies’ winning streaks short lived Karren Vergara

Crypto fortune and lost password A Bitcoin portfolio worth approximately $280 million could be lost forever, as its owner struggles to remember his password. Stefan Thomas, a developer based in San Francisco, remains unable to access his Bitcoin wallet. He said the incident is “a painful memory”. “I hope others can learn from my mistakes. Test your backups regularly to make sure they are still working. An ounce of foresight could have prevented a decade of regret,” Thomas tweeted. Thomas told the New York Times that he lost the paper where he wrote down the password for his IronKey, which would allow him to access the private keys to a digital wallet that holds 7002 Bitcoins. The IronKey allows users to have 10 password guesses before it encrypts its contents forever. Thomas has already had eight guesses, and no luck so far. “I got to a point where I said to myself, ‘Let it be in the past, just for your own mental health’,” Thomas told the New York Times. On Twitter, he saw the funny side of his situation, saying that he loved the suggestion from someone who read the article that it be turned into a movie where he “reconnects with some long-lost love that he thinks is the basis for the password but is not - he loses the money but gains something more.” fs

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The quote

Out of the topperforming funds in the 12-month period ending June 2016, only 1% persistently maintained a topquartile rank, and 2% consistently beat the benchmarks in the following four consecutive years.

ust one in seven Australian equities fund managers could beat the market year after year, according to S&P which tracked the persistence in returns over five years to June 2020. The report found their ability to consistently beat benchmarks and stay in the top quartile are fleeting. The S&P Dow Jones Indices’ biannual report found only a small number of outperforming or highperforming Australian fund managers were able to keep the momentum going. The biannual report Persistence Scorecard found very few outperformed their respective benchmarks or consistently stayed in their respective top quartiles over three and five consecutive years the over short- and long-term horizons. In June 2017, 203 actively managed funds were in the top quartile. Three years later, only 41 funds stayed at the top. Of the 78 top-performing Aus-

sie equity funds, just 11 consistently stayed in this bracket. REITs (18.8%) were the least persistent in staying above the fray, while bond funds (75%) tended to maintain top-quartile rankings. Over a five-year period to June 2020, only a third (31.3%) of the 166 funds analysed remained in the top quartile; about 11.4% were liquidated or merged. Aussie equity mid- and small-cap, and REITs failed to stay in the top quartile for five consecutive years. Bond funds, again, were persistent performers. The report found similar themes in terms of fund managers’ ability to outperform benchmarks consistently. “Out of the top-performing funds in the 12-month period ending June 2016, only 1% persistently maintained a top-quartile rank, and 2% consistently beat the benchmarks in the following four consecutive years,” the report read. fs

Pale, male and stale? Try deidentified CVs Elizabeth McArthur

If your firm is worried about its lack of diversity, there may be merit in stripping out identifiers from resumes in the recruiting process. Future Super, the $1 billion ethical retail fund, shared how its deidentified recruitment has helped boost diversity – after mixed results last year. Future Super head of group strategy Veronica Sherwood-Meares said on LinkedIn that Future Super now does not look at CVs or resumes when hiring. “At Future Super, we’re working to deliver a future free from climate change and inequality, and our actions need to match our words. However, our track record with the diversity of our own team hasn’t always been great,” she said. “At the beginning of 2019, more than 60% of our team were men and, even without any tracking of the share of our team who identified as people of colour, it was easy to see we were overwhelmingly white.”

But she said that since then the fund has managed to transform its diversity for the better. “Of the 15 new hires we had in 2020, 53% are women (we recognise this doesn’t speak to gender identities that sit outside the binary, and we hope to explore that over time, too), and 73% self-report as being a person of colour,” Sherwood-Meares said. She credits the improvement to shifting to a recruitment platform which deidentifies applications. The new recruitment style also sees the fund focus on asking questions of candidates that are based on testing the skills required for the job. This means candidates are less likely to be chosen purely on where they have worked in the past, rather on the skills they have acquired through their experience. “It’s really tempting to ask someone where they’ve worked in the past instead of crafting questions which test for the skills required for the job, but we’ve gotten used to sticking to the theory over time,” she said. fs

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Trust the process The Baby Boomer generation is on the cusp of the largest intergenerational transfer of wealth in history. With $68 trillion on the line, how do we ensure a smooth transition? Eliza Bavin writes. he Baby Boomers have meant T many things for the world. They were born from post World War II optimism and acquired vast amounts of wealth as they reached middle age. Now, they are about to embark on the largest intergenerational wealth transfer in history, with $68 trillion globally, and $3.5 trillion in Australia, set to be passed on to the next generation. While most of this money is held in individual retirement accounts, for many it is tied up in investments like equities and property. The question then becomes, how do we ensure the smooth transition of these assets without losing great chunks through complex legal and tax requirements? The answer for this is most often in establishing a testamentary trust which allows for any inheritance being passed on to beneficiaries while add-

ing additional protections and helping them achieve certain tax advantages. However, as many financial advisers are all too aware, there are issues that arise in every family that also need negotiating.

Supporting the bloodline On the surface one might think estate planning is simple; write a Will that leaves everything I own to my children. But, as Fitzpatricks Private Wealth senior adviser Trish Prince says, things are rarely that simple when it comes to any family. “Many people are concerned about the money they have worked hard for their entire life and how they are going to ensure it is passed on safely not just to their children but also to their grandchildren,” she says. Prince says she likes to “uncomfort-

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I like to put up a family tree and say ‘okay, who in the family doesn’t get along...’

ably disturb” her clients, in that she knows the only way to sort through potential issues is to get them all out on the table. “I like to put up a family tree and say ‘okay, who in the family doesn’t get along’ and create a safe space where they start to feel more comfortable and things eventually come out,” she says. “Then I ask them who they actually trust with their money and who they feel they can trust to be in control. There are always issues and family dynamics that have to be navigated.” For some it may be that while a couple may wish for their daughter to receive inheritance, they may not want her husband to receive any, for example.

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Another issue comes into play when you have blended families. Once you start to bring in children from previous relationships the family tree can start to get meddled. “What we offer, especially in circumstances where things are very fragmented, is to have a meeting with those who will be in control of the money,” Prince says. “This can help them understand the ‘why’. So, they know it wasn’t about excluding someone from benefitting but more about including the bloodline in benefitting and not those who may come along later.” Having a sense of understanding is extremely important, says head of strategy and development at Crestone, Clark Morgan. When establishing a trust it is not just about ensuring everyone understands who the beneficiaries are and why, but also what the purpose of the money is. “It is important to understand what a client wants to achieve. Is it an understanding of the values that they subscribe to and the ways in which they generated the wealth and then passing that on to the children,” Morgan says. “Or is it telling the next generation how you want that money spent; is it going into a charitable disposition, are you going to give it to the kids, is it just cash or is it for business?” Morgan says the best way to deal with conflicts in families is by setting up a dispute resolution. “If you set up a clear dispute resolution oath before any disagreement occurs you have a solid framework to refer back to,” he says. “In many cases we have seen families that have set clear guidance that unless you are a direct descendant that is bloodline of the parents you don’t get a seat at the table.” It may seem harsh, but many financial advisers understand these issues because they have seen it go wrong. Prince and Morgan agree that it is much better to have everything out on the table than to wait for issues to arise later. Lifespan Financial Planning compliance and technical officer Anna Mirzoyan says that because financial

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advisers are in most cases the first professionals to have these discussions with clients it is important to get the facts straight. She says in many instances clients simply don’t think that there is any need to go beyond having an up-todate Will. “It is great that the client has a current Will that reflects their wishes; however, they may also benefit from adding a provision to their Will to establish a testamentary trust for certain beneficiaries if need be,” Mirzoyan says. “Not having a complex estate or fancy investments should not be the reason for people to ignore the potential benefits of making a provision for a testamentary trust in their Will.” As Mirzoyan explains, this will give the executor of their estate flexibility and the ability to exercise discretion at the time and determine if there is a need for establishing a trust. “Yes, there is a cost involved in seeking professional advice, establishing the trust, and maintaining the trust and that cost is usually weighed against the potential benefits the trust can add to future beneficiaries’ financial circumstances,” she says. “The establishment of the trust is not limited to family members only. Charitable organisations or even pets may also benefit from the trust.”

Understanding jargon Understanding the legal requirements involved with establishing a trust is one of the most complicated factors after working through family dynamics. Prince works very closely with lawyers and accountants to ensure everything is prepared by the book. “We are not lawyers and at the end of the day unless you have studied the law in the way lawyers have you can’t profess to actually know the ins and outs,” Prince says. “I actually think it is dangerous if you think you can do it all. It’s not a negative to admit that you need someone else who is an expert to give you support so the client gets the right outcome.” While Prince is not a legal professional, special counsel at Australian Business Lawyers and Advisors

The quote

If you set up a clear dispute resolution oath before any disagreement occurs you have a solid framework to refer back to.

(ABLA) Erin Brown certainly is. Brown is a senior estate planning lawyer who advises privately held businesses, high-net-worth individuals and family groups in relation to both estate and business succession planning matters. “Financial planners normally help map out the goals of the person establishing the trust and create the path for other advisors, like lawyers and accountants, to establish the terms of the trust,” Brown says. “Probably the most common mistake we see when establishing testamentary trusts is a failure to consider who should act as the trustee of the trust, particularly where beneficiaries are unable to manage the trust themselves due to age, disability or other vulnerability.” Brown says she has seen a tendency for clients to automatically appoint family members to act as trustee without considering the pressure this may place on the trustee or the detriment that appointment may have for the relationship between the trustee and the beneficiary. “In some circumstances it may be prudent to consider whether an independent or professional trustee would be more appropriate,” she says. “Another common mistake is that the provisions of the trust do not adequately define the beneficiaries of the trust.” Brown says one of the more interesting things she has seen is the establishment of a trust where the intended beneficiary has inadvertently not been included as a beneficiary. “More commonly, we see trusts established for vulnerable beneficiaries where the nominated trustee is also a beneficiary of the trust,” she says. “Without adequate checks and balances in place, this can lead to the potential mismanagement of trust funds to the detriment of the intended beneficiary.”

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Finally, Brown says ABLA has also seen several trusts that do not include appropriate provisions for transferring control of the trust on the death of the existing trustee. “It may not be sufficient to enable the nominated trustee to decide how control is to pass and clients should give some thought to who the successor trustee may be if their first choice is not available for any reason,” Brown says. “It is important to get the trust right on establishment. It can be difficult and risky at times to amend the terms of a trust, especially after death, and getting it wrong can have serious consequences for beneficiaries.” Amending a trust can result in a resettlement of the trust with serious taxation consequences, Brown warns. Crest Accountants partner Wes Bothma knows all too well the ins, outs and complexities of tax consequences. Bothma says one of the biggest misconceptions clients have is believing a trust is some magical structure that can distribute profits to everyone in the family and not have to pay any tax. This, Bothma explains, is not the case at all. “By owning something in a trust they still think it’s their money but is now owned by the trust and would not form part of their normal estate, this is where a new trustee is appointed on death of current trustee and is typically nominated within that existing deed,” he says. “People earning income through a trust, such as personal services or professional services, believe income can be transferred out to other beneficiaries but Personal Services

Income (PSI) legislation requires that a professional’s income to be taxed in their hand at their marginal rates and ignores the specific entity that it was earned through.” The Australian Taxation Office (ATO) has established the legislation quite firmly. “Income is classified as PSI when more than 50% of the amount you received for a contract was for your labour, skills or expertise,” the ATO says. “The first thing you need to do is work out if any of your income is classified as PSI. If it is, you then need to work out if the PSI rules apply to that income.” This legislation has been created to improve the integrity and equity in the tax system. “This is by ensuring you cannot reduce or defer your income tax by diverting income received from your personal services through companies, partnerships or trusts,” the ATO says. It is important to note that PSI does not affect you if you’re an employee receiving only salaries and wages. However, if you are operating through an entity, such as a company, partnership or trust, and are an employee of that entity then the PSI rules may apply. It is legislation like this that makes seeking expert help extremely important.

APRA-regulated versus SMSF Especially so when it comes to the difference in whether the deceased held assets within a superannuation fund or a self-managed superannuation fund (SMSF). The tax implications are usually applied to

Figure 1. Proportion of inheritance money received by children of the deceased

30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% <40 Source: Grattan Institute

40-44

45-49

50-54

55-59

Age of recipient

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60-64

65-69

>70

the estate of the deceased, not to the newly established trust from the estate, says Mirzoyan. “For example, when a superannuation death benefit is paid to the deceased’s estate, the super fund does not deduct withholding tax from the taxable component before paying the amount to the estate,” Mirzoyan says. This is because the trustee of the super fund is unaware of the beneficiary’s circumstances, such is the beneficiary is tax dependent or a non-tax dependent. “It then becomes the responsibility of the executor to identify the right beneficiary, determine if the beneficiary was a dependent of the deceased for tax purposes at the time of death or not and withhold tax if relevant,” she says. “This means when the trust is established from the deceased estate, the tax liability has already been met by the executor of estate and the testamentary trust does not have initial tax liabilities.” Crestone head of wealth planning Maria Paonessa says with an SMSF there will be a binding death nomination benefit in place which will allow for flexibility. “You can either transfer the super fund assets to an individual beneficiary or nominate your estate, your legal personal representative, so that where the assets actually get transferred because a super fund is not an estate asset,” Paonessa says. “To make it an estate asset you need to nominate your estate, so your legal personal representative. This means, that it will allow the super fund assets to transfer in accordance with what the Will stipulates.” If the Will stipulates that the assets are going to a trust structure, that is how you transfer it over to an actual asset of the estate. So the binding death benefit must designate the assets to either go to an individual or via the Will into a trust structure. “With an APRA-regulated super fund it can be very similar. It all comes down to how you define, or how you chose to make that nomination as to where your assets are to go,” she says. Crest Accountants financial adviser Robert Hayward says there are some issues that arise with SMSFs especially where property is involved. “The asset on death can mean the property itself cannot be transferred out and would require the sale of the asset,” he says. “Whereas most other assets managed funds,

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cash, shares are liquid and can be moved on easier.” Hayward says that both SMSFs and APRA-regulated structures allow for beneficiary nominations both binding and non-binding. “Tax issues present when funds are paid to adult children who are not SIS dependent and taxable components of the funds will be taxed at 15% plus Medicare. Compared to transfer to spouse or dependent child where assets will be tax free,” Hayward says.

Keeping track Class is well-established in the SMSF space, where accountants use it for back office administration. Class SME senior analyst Angelique Faes says client conversations made the firm realise there was demand for similar features in the trusts space. And so, Class Trust was born. “One of the things we released early on were additional reserves with automatic journals so trust accountants can account for types of income that shouldn’t be included and they also have the flexibility to transfer income to a trust income definition reserve,” Faes says. “We added different options really focusing on the common income determinations that are often seen in a trust deed. So, underordinary concept or income equalisation clause.” By adding extra options around the treatment, such as for capital works deductions, it has allowed Class to cater for the flexibility that is so often needed. Faes said Class Trust was born out of in-depth discussions with accountants around their current processing of trusts and identifying their real pain points. “What they were telling us was that it could easily take them a day or two to process a trust that had good portfolio investments with local and international shares,” she explained. “And all of that work was being done on Excel spreadsheets. It was really complex, and it meant accountants couldn’t pass on the administration side to juniors because it would be too complex for them.” Everything can now be automated with Class Trust. Bank feeds, income,

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corporate actions, all the key parts of administering an investment a trust are now taken care of for them. Faes says that this is vital, because when using spreadsheets, there can be a lack of consistency. As she points out, many people have their own quirks and way of doing things that made it difficult to pass on the workload to someone else within a firm. “And the elephant in the room previously was that someone might forget a corporate action, miss a dividend or maybe they forget about a related party transfer,” Faes explains.

It is all equal Clearly, the complexities of estate planning require many conversations and thorough planning, but it is vitally important. Many advisers find themselves needing to explain that trusts are not just a tool for the wealthy, but a good way to protect the assets they are leaving to their family. Generation Life offers investment bonds as an alternative to trusts. Working in a similar fashion, a person can establish an investment bond to hold their investments or assets and designate a beneficiary. Generation Life chief executive Grant Hackett says he has heard horror stories of families that have contested a Will over relatively small amounts of money. Had the deceased established a bond, or trust, those family issues could have been avoided along with costly court proceedings. “This is not just for the wealthy. We see a lot of grandparents whose kids might be divorced, or have a blended family situation, and they want to bypass that generation and leave something for the grandkids,” Hackett says. “A bond is a great way for them to be able to bypass that generation and leave a set amount of money for the grandchildren to put towards their school fees, for example.” Hackett has been seeing a lot more use of these kinds of measures across all estates, not just multi-million dollar ones. “It can help provide some reassurance to the client and we’ve noticed

The quote

The biggest misconception that clients have about trusts is that they are only for families with a high-net worth or the ultra-wealthy.

they can be quite chuffed about the fact that they know everything is set up for their grandkids and going to be distributed as per their wishes,” he says. For Prince, the matter is quite personal. Having lost her husband, and now raising their daughter alone, they were fortunate to have had a trust in place to ensure they were both protected. “I needed a trust because I am a financial planner, and so from an asset protection point of view, the wealth that my daughter and I inherited is via a trust,” Prince explains. For Prince, she can rest assured that her daughter will be taken care of and whatever is in that trust cannot be accessed by anyone else. She even jokes that if anyone were to sue her all they would get is her trusty Toyota RAV4. Brown agrees that the real value in trusts comes from the asset protection side; beneficiaries do not own the assets. “In our experience, the biggest misconception that clients have about trusts is that they are only for families with a highnet worth or the ultra-wealthy,” Brown says. “While trusts are often established to protect wealth, it is common for those with even modest estates to utilise trusts to ensure hard earned assets remain within the family or to protect vulnerable beneficiaries.” Brown says that while many clients share concerns around the costs associated with establishing and running a cost, at the end of the day it is a worthwhile endeavour. “While it is true that there are additional costs to establish and maintain a trust, these costs are often insignificant when compared to the year-on-year savings that can be generated by appropriately structured testamentary trusts,” she says. fs

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THE WELLNESS MILLIONAIRE Radek Sali, Light Warrior Radek Sali joined the ranks of Australia’s wealthiest when his former company Swisse Wellness was acquired. The family office investor talks to Kanika Sood on how he invests and the opportunities he sees in 2021.

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n September 2015, Hong Kong-listed Biostime paid $1.7 billion for a majority stake in giant with health supplements manufacturer Swisse Wellness. The company had grown from a small organic bakery in Melbourne’s St Kilda to an giant with A-listers like Nicole Kidman, Ellen DeGeneres and Ricky Ponting as its brand ambassadors. The sale meant a big payday for Swisse’s founder Kevin Ring. But also for its chief executive Radek Sali, who was only 38 at the time. Sali can rightfully be described as a corporate prodigy. He started at the candy counter in a cinema owned by Village Roadshow at 18 and was in middle management by the time he left as a 28-year-old. He joined Swisse next, making chief executive in three years, just as he entered his 30s. After the Swisse sale, Sali walked away with about $250 million. He set up his own single-family office, Light Warrior, whose investment team currently manages about $130 million on his behalf, occasionally partnering with outside organisations. He now comes into its Melbourne offices on Tuesdays and Wednesdays, while working from home Mondays and Fridays. It’s not a laidback family office but an active business with operating stakes in many companies. Sali says his decision to start a single-family office instead of surrendering the management of all his assets to a high-net-worth advice firm boiled down to two reasons: a desire to invest in non-vanilla

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assets, and to be operationally involved in his portfolio companies. “Mainly, because what we were looking to do is so different to your standard offering out there. And that’s taking nothing away from those offerings, we’ve been invested into a few of those along the way on our journey,” Sali says, adding Light Warrior still uses Escala Partners for some investment-grade assets. “Also, I am only 44. So, I do like to be operational and I really enjoy working with the team on the businesses that we’re in, and also being across the funds we do.” About six months after Swisse’s sale, Sali’s assets were mostly tied up in Swisse and Biostime stock, according to an April 2015 interview with the Australian Financial Review. About 40% was in fixed income and cash, while 10% was in venture capital. In the same interview, he expressed an interest in making venture investments. In the six years since, Light Warrior has increasingly diversified its portfolio, dividing it into ventures and investments. It has also invested in property, including apartment blocks. In investments, which includes bonds, listed companies and REITs, Light Warrior aims for 7 to 12% in annual returns. On the venture side, it wants outsized returns from two to four of the eight portfolio companies. Last year, it took some profit from its bond investments, which yielded about 9% return in the end, he says. On the venture side, Light Warrior currently leans heavily towards Sali’s areas of expertise in wellness and marketing. Hydralyte sells hydration electrolyte, Made By Cow sells dairy

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products made from raw milk, Stratosphere is a full-service advertising agency, and myDNA uses DNA analysis to suggest meal and fitness plans. Other businesses include Adventus, a platform connecting international students with universities and recruitment agents, and OurCrowd, a platform for investing in venture capital opportunities. Light Warrior hasn’t had any exits yet in its venture portfolio but Sali says many companies are now paying good dividends. “We are very close to doing a number but COVID slows things down. But we really see the investment profile in ventures being seven to 10 years. Sometimes you do get some away earlier than expected and that very much looks the case in 2021,” he says. And Sali points out that two of its portfolio companies, MyDNA and Made by Cow, doubled their valuations in recent raisings. The young family office faces a challenging investment landscape in low rates and high asset prices. Sali says looking into 2021, Light Warrior’s focus will be on ventures in financials(it already has stakes in real assets boutique Conscious Investment Management and bond manager Jamieson Coote Bonds), wellness and consumer products. “I think we’re probably going harder on ventures where we know [the space]. We will continue to invest in those and to grow those. We’re pretty optimistic about that part of our business [but] the investment side of things, I still think it’s a wait and see really, when we don’t know which way the market is going to be,” he says. “And maybe this is the new normal, where there isn’t certainty, perhaps like there would have been in the golden years of investments – though I am not sure when they were,” he laughs, adding equities, gold and cryptocurrencies have all gone through the roof. Light Warrior has weighed up the latter and decided to make a small allocation when the price is right, Sali says. “Well, we’ve had a lot of papers that we’ve reviewed over the last few years, and whether it’s worthwhile doing something,” he says. “But you know, the dynamics do suggest that when governments are printing money like they are and crypto, being finite like it is – it’s something to think about. But it’d be a very, very small portion of the investment portfolio.” The investment team that Sali mentions employs a staff of six. It is headed by Adam Gregory, a former Goldman Sachs investment banker whom Sali met around 2013 on Swisse’s business. Eventually, as their Swisse relationship was coming to an end, the idea of working together came up in conversations between the two. “You really get a sense of how committed someone is to doing the right thing and getting a job done. I had a front-row ticket to see him in action and I was

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immensely impressed,” he says of Gregory’s work for Swisse in the period. As for why Gregory accepted the role at Light Warrior, it was likely good timing and the chance to do something new, Sali posits. “He had done over a decade at Goldman, that’s a fair run for an investment banker. It’s a very demanding environment and it also created an amazing foundation of skills…I think that the time was ripe [for Gregory] to transition out of that banking world and…[an] opportunity to get a piece of action on the venture side,” he says. On the way, Light Warrior has had a few misses. It invested in celebrity chef George Calombaris’s Made Establishment months before an million wage underpayment scandal hit the newspapers, and the company became insolvent. As his best investment so far, he counts using his superannuation to buy Swisse shares. His worst? Spending $70 million including on celebrities like Nicole Kidman and Ellen DeGeneres to enter the United States with Swisse. Products didn’t hit shelves and the company piled on debt without booking any profit.

The quote

And maybe this is the new normal, where there isn’t certainty, perhaps like there would have been in the golden years of investments – though I am not sure when they were.

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The quote

We have massive visions of being in anything and everything.

Until, surprisingly, Chinese-origin shoppers in Australia discovered the brand. “So, I’m always very careful [with picking] the worst investment because I think you actually don’t know how bad an investment is until you look at it with full retrospective and [have] got a sense of the wins and losses – the real wins and losses,” Sali says. Light Warrior has increased its focus on making socially-minded investments, as it has aged. “We wanted to find investments that delivered liquidity and return. But also, we are also about creating social purpose and using capitalism for good. “We found that really hard to find. I mean, you can find socially-minded, listed entities – anyone could go and do that. We just found that what we were looking for is something quite unique and differentiated in the market,” he says, adding that’s how the investment in real assets manager Conscious Investment Management came about. Conscious was started by former Goldman Sachs investor Matthew Tominc, who previously worked for Light Warrior, and invests in property and infrastructure like specialist disability accommodation, affordable housing, community rooftop solar and social impact bonds. It follows an “impact partner model”, partnering with charities and similarly-minded enterprises to work together to identify investments and assist with the management. Last year, it tied up with a consortium of investors including the influential Ramsay Foundation to invest $48 million into 60 disability accommodation apartments. Sali’s next big thing for 2021 is a venture called Light Warrior Wellness. It will release a new range of products in May. “It’s a pretty good time to be starting up a business because you don’t really have to worry about those external factors. In the year we’ve just had, but you know, we’re really primed to deliver that range,” he says. He takes cues from Richard Branson, whom he lists as a family office investor he looks up to. “I regularly catch up with him...I think he’s in over 300 different ventures, so very diversified,” he says. For his own family office, Sali is equally ambitious. “We have massive visions of being in anything and everything. I think that it does again come back to [that] we’re just driven by making a difference. And if we need to become bigger to do that, we strive to do that,” he explains. “And you know, I don’t have to work but I’m working because I love what we do.” Outside of Light Warrior, he eats healthy “maybe 80% of the time”, likes to play golf more for the walkand-talk than for the sport, and sits on boards of seven not-for-profits. He and his wife, Helen have a two-year-old daughter. Helen Sali headed Swisse’s marketing for seven years and now is a co-founder of the Lightfolk Foundation.

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The two met at Prahran’s Boutique nightclub which has since closed. “I basically knocked over her drink and said, ‘Can I buy you another one?’” Sali’s father immigrated from Albania. His mother was from the communist Czechoslovak Socialist Republic, who came to Australia escaping the Prague Spring. Both became academics in medical science. Sali’s paternal grandparents farmed tomatoes in Shepparton. His father picked them and dropped them at the factory in Cremorne, where Sali and his investment team now go to work at Light Warrior’s offices. It’s not just the office space but also Sali’s car of choice that has links to his childhood. “The reason why I’ve got that Ferrari is my father bought a four-seater Ferrari, [on] the day I was born. And I always promised myself that when I could afford it, that that’s what I would do.” “So, on the day I sold Swisse, the money transferred, I went down and I bought myself exactly that same model the father bought when I was born as a celebration. So that’s my car.” The Lightfolk Foundation has supported initiatives at Hawthorn Football Club, La Trobe University, National Institute of Integrative Medicine, Igniting Change and B Team among others. National Institute of Integrative Medicine was established by Sali’s father, Avni Sali. Swisse’s then director Michael Saba in 2012 defended the company’s use of research where the older Sali had been one of the researchers. As his favorite book, Sali lists a title published by Igniting Change. The Art of Pollination by Martin Flanagan tells the story of charity worker Jane Tewson who founded the nonprofit and in the past worked on Comic Relief. Sali and Richard Branson are both supporters of the charity, while Tewson is a long-standing trustee of Virgin Unite. He says he is supportive of The Giving Pledge, an initiative by Bill Gates and Warren Buffett that urges billionaires to commit publicly to donating majority of their wealth to philanthropy (political donations don’t count). “It is a wonderful initiative. I spend 50% of my time working hands-on in not for profits. And that gives me the most joy,” he says. When asked what he would like his family’s legacy to be, Sali recalls his grandparents humble start and his relatively more comfortable childhood. “I’ve tried to make the most of that in being successful with business, but now also using that success to make a difference in society,” he says. “So, if our legacy can be for our organisation to continue to do that beyond our time on this planet, and many other organisations [are] inspired by what we do – we are very, very satisfied.” fs

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Benjamin Ong director of economics and investments Financial Standard

Sector review More quantitative easing he Reserve Bank of Australia (RBA)painted a T pretty picture of the Australian economy in its first board meeting for 2021.

The Good Economics Guide Making sense of key economic data

Your definitive handbook to understanding the Australian economy

Edition

The guide Ben Ong is the author of the Financial Standard Good Economics Guide: Making sense of key economic data, a handy reference tool for investors, analysts, strategists and finance commentators, available in newsagents.

RBA governor Philip Lowe’s statement at the conclusion of the Australian central bank’s February meeting was optimistic. “In Australia, the economic recovery is well under way and has been stronger than was earlier expected...underpinned by Australia’s success on the health front and the very significant fiscal and monetary support,” Lowe said. “The recovery is expected to continue, with the central scenario being for GDP to grow by 3.5% over both 2021 and 2022. GDP is now expected to return to its end-2019 level by the middle of this year.” However, the RBA’s action betrays its optimism. While the RBA kept interest rate settings unchanged – official cash rate and yield on three-year Australian government bonds at 0.1% – it also decided to purchase an additional $100 billion of bonds issued by the Australian government when the current bond purchase program is completed in mid-April. These additional purchases will be at the current rate of $5 billion a week. Lowe’s statement explains the method for the seeming “madness”. “The economy is expected to operate with considerable spare capacity for some time to come. The unemployment rate remains higher than it has been for the past two decades and while it is expected to decline, the central scenario is for unemployment to be around 6% at the end of this year and 5.5% at the end of 2022,” he said, despite the optimistic growth outlook. Lowe added that wages and price pressures have also remained subdued. Whilst he acknowledged

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both inflation and wage growth are expected to pick up, he expects it to be slow. The RBA board believes wage growth and inflation will remain below 2% over the next couple of years. “In underlying terms, inflation is expected to be 1.25%% over 2021 and 1.5% over 2022,” Lowe said. “An important near-term issue is how households and businesses adjust to the tapering of some of the COVID support measures and to what extent they will use their stronger balance sheets to support spending.” Additionally, investor housing and business credit growth remain weak despite highly accommodative financial conditions and, the exchange rate has appreciated and is in the upper end of the range of recent years – this was since early 2018. Akin to China, the Australian dollar has become the “victim” of Australia’s success in controlling the COVID-19 outbreak and its variant and in strengthening domestic economic growth and employment. Likewise, Treasurer Josh Frydenberg ruled out the possibility of extending the government’s JobKeeper scheme beyond the end of March this year, the onus of Australia’s complete resurrection falls back onto the RBA’s shoulders. And Lowe said, it was up to the task. “The board will not increase the cash rate until actual inflation is sustainably within the 2% to 3% target range. For this to occur, wages growth will have to be materially higher than it is currently. This will require significant gains in employment and a return to a tight labour market. The board does not expect these conditions to be met until 2024 at the earliest,” he said. Perhaps, by then, Australia’s become amigos para siempre again with China. fs

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News bites

US employment Latest US Bureau of Labor Statistics (BLS) data showed the economy added 49,000 heads to nonfarm payrolls in January. This is lower than market expectations for a 50,000 increase and followed the distribution of 227,000 pink slips in December 2020. What is more, the downward revisions in November and December showed there were 159,000 less Americans in employment in those two months than previously reported. Moreover, in spite of the January gain, the US economy remains around 10 million jobs short of the peak recorded in February last year. Similarly, while the unemployment rate dropped to 6.3% in January 2021 from 6.7% in the previous month, it’s still far above the 3.5% pre-pandemic rate.

Property

Prepared by: Rainmaker Information Source: Cromwell Property Group

Jamie Williamson

rise in positive sentiment was recorded A across all states and territories of Australia at the beginning of the year on the back of expectations of low interest rates buoying property prices. According to ME Bank’s latest Quarterly Property Sentiment Report, positive sentiment is the highest it has been since 2019 while negative sentiment is the lowest it has been in the same period. Investors and owner-occupiers were considerably more positive in January 2021 than in October 2020, with positive sentiment among the cohorts increasing by 15 and 17 percent-

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Indonesia GDP Is Indonesia in recession or not? The latest update showed the country’s GDP declined by 0.4% in the three months to December 2020, but this followed a 5.1% growth in the previous quarter. This doesn’t satisfy the technical definition of a recession. But take the year-on-year measure and Indonesia’s economy had been contracting for three straight quarters – 5.3% in the June quarter; 3.5% in the September quarter, and 2.2% in the December 2020 quarter. For the full-year 2020, Indonesia’s economy shrank by 2.1% – the first full-year contraction since the 1998 Asian financial crisis. This time, it’s due to the COVID-19 pandemic.

Australia trade balance The Australian Bureau of Statistics (ABS) reported that the country’s trade surplus increased from A$5.01 billion in November to A$6.79 billion in December 2020 – the biggest surplus in six months. This is despite increasing diplomatic and trade tensions with China, its biggest trading partner. The larger than expected surplus in December was due to a combination of higher exports – up by 3.0% from November to a nine-month high of A$37.27 billion – and a 2.0% fall in imports to A$30.48 billion. The details of the report showed goods exports to China increased by 21% over the month as shipments of iron ore jumped in both volume (16%) and value (25%). fs

Housing market sentiment lifts to three-year high age points, respectively. However, first home buyers were slightly less positive, with sentiment falling four percentage points to 27%. On a state-by-state basis, Queenslanders are the most positive in the nation, recording 56% positivity for metro areas and 58% for regional property markets (43%). Overall, of those looking to buy, 72% said stimulus measures such as HomeBuilder, incentives for first-time buyers and stamp duty relief in some states made the idea of buying or investing in property more attractive. A further 79% cited the record low interest rate environment as a driver for their interest. “While there are still many challenges such as unemployment and job insecurity, it’s promising to see how sentiment and market activity have rebounded,” ME Bank head of home loans and personal banking Claudio Mazzarella said. “We fully expect to see property investors back in full force this year. Sentiment within

this group is bouncing back, with low interest rates make investing in property a more attractive option.” About 77% of those surveyed by ME Bank said they expect property prices will “bounce back” this year. In line with this, less property owners are worried COVID-19 will impact the value of their property. Fifty-four percent of those surveyed said property prices will go up over the next 12 months, while only 7% said they think they will go down. Owner-occupiers are the most confident, with 57% expecting them to rise. However, the obvious issue the data presents is that higher house prices exacerbate the housing affordability issue that has plagued Australia for some time. Of those surveyed, 95% said affordability is a “big issue”. “…it will make it harder for first home buyers to get their foot in the door. It will be important for new entrants in the property market to do their research,” Mazzarella said. fs

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Key indicators

Source:

Monthly Indicators

Jan-21 Dec-20

Nov-20 Oct-20 Sep-20

Consumption Retail Sales (%m/m)

-4.06

7.11

1.79

-1.52

Retail Sales (%y/y)

9.60

13.33

7.05

5.17

11.06

13.55

12.39

-1.50

-21.77

Sales of New Motor Vehicles (%y/y)

Inflation CPI (%y/y) headline

0.86

0.69

-0.35

2.19

1.84

CPI (%y/y) trimmed mean

1.20

1.30

1.70

1.50

CPI (%y/y) weighted median

1.40

1.20

1.30

1.60

1.20

Output

Employment

Real GDP Growth (%q/q, sa)

3.33

-7.03

-0.28

0.39

Employed, Persons (Chg, 000’s, sa)

Real GDP Growth (%y/y, sa)

-3.82

-6.36

1.37

2.16

0.30

-2.91

0.29

0.39

Job Advertisements (%m/m, sa) Unemployment Rate (sa)

50.04

90.00

180.37

-44.15

2.33

8.63

14.26

11.87

7.08

Industrial Production (%q/q, sa)

6.60

6.83

6.99

6.91

Survey Data Private New Capex, Total, Chain, Vol, (%q/q, sa)

Housing & Construction Dwellings approved, Tot, (%m/m, sa)

15.82

6.62

5.08

12.15

Dwellings approved, Private Sector, (%m/m, sa)

10.92

3.37

4.91

16.82

Survey Data

Financial Indicators

-3.04

-6.36

-2.04

-3.04

08-Jan Mth ago 3 mths ago 1Yr Ago 3 Yrs ago

Interest rates RBA Cash Rate

0.10

0.25

0.75

1.50

Consumer Sentiment Index

107.00

112.00

107.66

105.02

93.85

Australian 10Y Government Bond Yield

1.20

0.95

0.74

1.03

2.94

AiG Manufacturing PMI Index

55.30

52.10

56.30

46.70

Australian 10Y Corporate Bond Yield

1.30

1.27

1.42

1.81

3.26

NAB Business Conditions Index

7.16

15.79

8.04

3.17

1.15

NAB Business Confidence Index

10.05

4.71

12.55

4.13

-2.38

Trade Trade Balance (Mil. AUD)

6785.00

5014.00

6536.00

5743.00

Exports (%y/y)

-7.79

-11.09

-12.78

-20.90

Imports (%y/y)

-13.10

-9.84

-20.74

-22.88

Quarterly Indicators

Dec-20 Sep-20

Jun-20 Mar-20 Dec-19

Balance of Payments

Stockmarket All Ordinaries Index

7112.9

2.26%

12.12%

0.45%

16.06%

S&P/ASX 300 Index

6828.1

2.36%

11.58%

-1.50%

14.08%

S&P/ASX 200 Index

6840.5

2.37%

11.42%

-1.94%

13.51%

S&P/ASX 100 Index

5642.0

2.44%

11.48%

-2.44%

13.62%

Small Ordinaries

3190.3

1.81%

12.26%

6.28%

17.59%

Exchange rates A$ trade weighted index

63.00

63.40

59.50

58.10

65.60

Current Account Balance (Bil. AUD, sa)

10.02

16.35

7.23

3.45

A$/US$

0.7659 0.7729 0.7273 0.6745 0.7938

% of GDP

2.06

3.49

1.43

0.68

A$/Euro

0.6369 0.6296 0.6149 0.6130 0.6391

A$/Yen

80.77 79.45 75.38 74.02 87.40

Corporate Profits Company Gross Operating Profits (%q/q)

3.22

15.84

3.02

-3.71

Commodity Prices

Employment

S&P GSCI - commodity index

Wages Total All Industries (%q/q, sa)

0.08

0.53

Wages Total Private Industries (%q/q, sa)

0.53

-0.08

0.38

0.45

Wages Total Public Industries (%q/q, sa)

0.45

0.00

0.45

WTI oil

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450.61

420.63

354.90

386.28

451.60

Iron ore

153.90

166.08

116.92

79.87

76.00

Gold

1802.95 1940.35 1938.45 1553.30 1333.60 56.85

49.78

38.56

50.87

64.18

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Family Office Management:

Transition choices when your business is part of the family

By Steven Shultz, EY

Trust and understanding in business-owning families

By Barclays Private Bank

Family Office Management

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CPD Earn CPD hours by completing the assessment quiz for this article via FS Aspire CPD. Worth a read because: Cohesive family, wealth and business governance is key to successful transition planning, avoiding confusion and upholding a current owner’s ambitions and legacy. Further, a detailed understanding of business and family assets is essential. Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

Transition choices when your business is part of the family Making the right decisions

C Steven Shultz

OVID-19 has shown how transitions of family values, business and wealth deserve thoughtful attention now more than ever.

In brief

• The world is changing faster than ever, and families need to build in flexibility and agility to future proof their planning. • Understanding the detailed composition of your business and family assets right now is fundamental to effective transition planning. • Listening to family members and implementing robust family governance is key to bringing through the next generation. Critically acclaimed HBO TV program Succession picked up the Golden Globe award for Best Television Drama Series in January 2020 and the Emmy for outstanding drama series in September 2020. The hit series is rife with family conflict, betrayal and drama as it follows the lives of the Roy family amid a generational transition and the prospect of the patriarch stepping back from his media conglomerate. Succession is, admittedly, an exaggerated (and fictional) example of what can happen when parents and children clash over family business and wealth transfer, and the related impact that it can have on the com-

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munity and employees that benefit from successful family firms. But real life can sometimes prove equally, if not more, challenging. Two months after the Golden Globes, the world was changed beyond recognition as the COVID-19 pandemic hit, countries went into lockdown, markets were disrupted and many businesses, including those that are family-run, had a unique need to rethink their plans and operations. Even now, the need for those plans and operations to adapt to the changing business landscape continues. “It’s common for families to consider wealth transition only during times of conflict or on the death of the patriarch or matriarch,” Desmond Teo, EY’s Singapore-based Asia Pacific family enterprise leader explained. “But the one thing that the pandemic has shown is a real need for families to get on top of their transition plans now, so that when inevitable events out of your control arise, you are better positioned to deal with them.” According to Knight Frank’s The Wealth Report 2018, only 26% of families have a full wealth transfer plan in place. Resilient families and businesses are taking the opportunity to regroup and refresh around their generation transition intentions. There is no one-size-fits-all solution when it comes to family wealth and business succession. However, whether you are start-

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Family Office Management

ing your transition planning from scratch or reviewing your existing plans in light of COVID-19, there are some practical steps that you can take to ensure your transition plans support your ambitions and legacy.

1. Take stock of your plans and legacy Knowing where you stand right now creates the foundation for effective and robust planning. While it makes perfect sense under any circumstances to take stock of your business and wealth position, there are even stronger incentives to do so now. As Tom Evennett, EY UK&I family enterprise leader, EY Private Tax, UK&I, highlighted: “When you take into account properties and assets held, investment portfolios, trusts and foundations and so on, your personal holdings may present a complicated picture. And that’s before you factor in the family business value creation and preservation, which can add another critical dimension.” It is highly likely that your holdings will have been affected in some way by the pandemic. Your investment’s value and risk profile may have changed, or your business may have faced profound disruption. It is only by understanding the full picture that you can start to devise a plan, which could possibly include looking for new opportunities as well. As Marianne Kayan, manager, individual global tax planning, personal financial services, national tax, EY Private Tax, Americas, noted: “There are many reasons why families don’t have a proper transition plan in place. As the head of the family, you may fear that you are somehow relinquishing control and, having built up a business, don’t want to hand it over. Similarly, you may think it only makes sense once you are ready to retire. While this is, perhaps, understandable, a lack of planning can put you in a vulnerable position.” By developing and implementing a wealth transfer plan, you can ensure that a range of short-, medium- and longer-term objectives are addressed. This may involve assigning both family members and advisers to create, deploy and execute the plan. It will need to consider a range of factors that are addressed in the following sections.

2. Consider family and business as separate parts of the whole Understanding the disparate parts of the family wealth picture will help with comprehensive planning. While there will be a natural crossover between family and business considerations, a distinctive succession plan to support the transition needs of the business is critical. Leading practice business transitions often happen while current owners, founders and leaders are alive and active. One of the key considerations is clarity on the options and intentions for what is going to happen to the business itself. Will it be sold, or will the next generation assume leadership, management and ownership? Having those conversations now is really valuable.

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If your family has one or more businesses as part of your asset base, you should consider the performance of that business as an important component of your family wealth transition plans as well. Your family will want to ensure the key performance indicators for business performance are working as intended to support and protect value across generations. Family offices are increasingly playing a strategic role in facilitating a smooth transition of wealth from one generation to the next. Not only can a family office support you with traditional wealth management considerations, it can also play a key role in supporting family continuity, legacy, philanthropy, impact investing and other endeavours of importance to the family at large.

3. Do not lose sight of the changing tax landscape Staying on top of shifting tax regulation can help ensure you remain compliant across jurisdictions. The global tax landscape has become increasingly complex and important for families of all profiles. Tax policies are often central in government, social, and economic considerations, impacting business-owning families and their business interests. These strategic tax considerations only amplify for multi-jurisdictional families with business and personal interests in multiple locations. The tax landscape of the locations where you and your family live and conduct business plays a significant role in a well-thought-out wealth transition plan. There are the traditional tax concerns – inheritance taxes, business

Steven Shultz, EY Shultz is the global private tax leader at EY. His team brings a unique focus at the intersection of owners, families, and their businesses. He has worked with entrepreneurs and business builders throughout his career, with a particular focus on supporting their tax and financial agendas.

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Family Office Management

taxes, transfer taxes, individual taxes, country tax schemes – all of which you must consider. “Wealthy families are becoming more international and will need to consider the associated complexities, or there could be a risk of underestimating the implications,” Dr Christian Steger, head of private client services, EY Private Tax, Germany, explained. “Issues around dual residency, exit tax and general tax compliance in multiple jurisdictions definitely need to be taken into consideration early and regularly.” Many countries are making changes to their tax regimes in response to the COVID-19 pandemic. Now more than ever it is critical to ensure personal and business tax positions are central to any strong succession plan. [As mentioned] tax policies are often central in government, social, and economic considerations, and they only amplify for multijurisdictional families with business and personal interests in multiple locations.

4. Understand and consider all family stakeholders Recognising the hopes, plans and expectations of family members will drive future planning. Family is complex, and an important part of your wealth-transition plan is defining actually whom you consider ‘family’ in the context of your planning. On a simple level, this can boil down to who the beneficiaries will be and the practicalities of estate or inheritance planning, such as ensuring a proper Will is in place and the establishment of appropriate trusts and foundations. That being said, as

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much as there are financial implications, there are also non-financial matters that you want to address. Generational ambitions and priorities may well differ significantly. Often, the next generation may be more international in its outlook, perhaps living or being educated in more than one country. They may prioritise social or environmental priorities in different ways. It is also possible that they may have family structures or lifestyles that differ meaningfully from the prior generation. “When it comes to participating in the family business or any philanthropic endeavors, it’s really important to consider family capital,” Heather Greatrex, EY Oceania family enterprise leader, EY Private Tax, Australia, explained. “This concept is discussed by Dr Lee Hausner in her book The Legacy Family [co-written with Douglas K Freeman] and involves human capital, intellectual capital, social capital and financial capital. In other words, what skills do the next generation of family have that they can bring to the table?” It is no longer a given that children will enter the family business – indeed, it might not even make sound business sense for them to do so. Likewise, you may no longer dictate the role of the next generation in family affairs. As such, leading families are asking themselves questions such as: • Would the next generation like to be actively involved in the business or managing family affairs, and would they have a preference? • Do family members have expectations or their own personal ambitions? • Do they share the same vision of the future? • Are children qualified, prepared and willing to assume a future leadership position? Talking to and, critically, listening to the next generation is really important right now because their attitudes and priorities may have changed in light of the pandemic. Finding out where they stand now can be important in avoiding future conflict.

5. Educate the next generation Teaching future family leaders about business and wealth management lays important groundwork. One of the challenges you may face during family wealth and business succession is whether the next generation are actually ready to assume the roles and responsibilities that they are or will be taking on. “Studies show that many succession failures were caused by inadequately prepared heirs,” Todd Angkatavanich, principal, national tax department, EY Private Tax, Americas explained. “Not only might the next generation have insufficient business acumen, they also might have limited understanding about the management of wealth generally.” As a result, education is critical to ensuring a smooth transition. This is something that can be put in place very early on – whether that is learning leadership skills, the fundamentals of running a business, or the basics of how investment markets operate. In the current climate, crisis management may well be something you want to build in for your future leaders.

6. Create and sustain a high-performing governance structure Implementing cohesive family, wealth and business governance creates a solid future-facing framework.

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As much as it is crucial for a business to have proper policies and procedures in place, the same can be said for family governance. The larger and more diverse your family is – including geographic diversity – the greater the need for proper protocols. Understanding where family governance fits within the three buckets of the overall governance structure is necessary to ensure you have a process to manage communications and both shared and divergent interests with family members: 1. Family governance: Includes oversight of the family’s shared vision and values, who is part of family, and formal structures such as a family council or family assembly. 2. Wealth governance: Can be thought of as who controls distributions of the wealth, such as trustees of a trust, managers of an investment entity or executives of a foundation. 3. Business governance: Includes oversight of investments, business and investment companies, formal boards and advisory boards, and selection of executive management. The required governance structures can cover a broad range of areas. It is important that the governance systems work in parallel with each other and that boundaries are set between the business and the family to avoid possible confusion and subsequent conflict. A starting place for family governance is the creation of a family council, which can make decisions on behalf of the family as a whole, oversee family voting on key family governance issues, as well as managing and resolving family disagreements. Families with business concerns need to consider how to integrate the family governance with existing corporate and wealth governance structures. “Having these structures in place helps improve governance and family cohesion,” Jean-Marie Hainaut, partner, business tax advisory, EY Private Tax, Switzerland, explained. “It gives you a point of reference to say this is what was decided as a family. It makes dialogue so much easier.” Conflicts can arise from a lack of education, a lack of communication and a lack of clear vision. “When you consider that a high percentage of successions fail because of a breakdown in trust and communication within the family unit, the importance of proper governance for family, business and wealth can’t be overstated,” Bobby Stover, EY Americas family enterprise and family office leader, EY Private Tax, Americas, said. .

7. Make sure your plan is agile, relevant and sustainable

Building in flexibility means your succession plan can move with the times and as the world changes. A succession plan is a living thing. Tax and business rules will continue to shift, family relationships will change, and birth, death, marriage, and other life events will alter the dynamics of the family. And, as we have experienced in the COVID-19 pandemic, and previously in the 2008 financial crisis, global events can come from nowhere and have an impact on your best laid plans. Being proactive is the best way to manage your family’s transition planning. In our experience, families that formalise and agree [on] responsibilities for succession, and who renew and revisit generational and wealth transition planning on a regular basis fare the best. Establishing a process to review your plan regularly – ideally annually – is critical. fs

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CPD Questions Earn CPD hours by completing this quiz via FS Aspire CPD 1. Under a high-performing governance structure, decisions regarding income distributions from trusts and other investment entities would fall under: a) Business governance b) Family governance c) Wealth governance d) Income governance 2. Why is tax planning considered to be central to any strong succession plan? a) Most transitions occur after an owner’s death, resulting in liability for payment of death taxes b) The increasingly international diversity of business and family wealth c) Family members will be subject to tax liability at different marginal tax rates d) Assets will almost certainly need to be transitioned across different tax regimes 3. The paper suggests it is important for the next generation of future leaders to be encouraged to gain skills in: a) Family management b) Crisis management c) Financial management d) Tax management 4. Which of the following actions is vital for a successful succession plan? a) E nsuring it remains dynamic, sustainable and revisited on a regular basis b) Accounting for all personal, business and family assets that form part of overall wealth transfer c) Understanding the ambitions and priorities of all relevant family members d) All of the above 5. L eading business transitions commonly occur while current owners/founders remain active within the business. a) True b) False 6. 13% of families have a full wealth transfer plan in place according to Knight Frank’s The Wealth Report 2018 a) True b) False Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

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CPD Earn CPD hours by completing the assessment quiz for this article via FS Aspire CPD. Worth a read because: The scale of upcoming intergenerational wealth transfer is a high-agenda issue for many family businesses, often fraught with emotion and friction. This paper examines how differences in family members’ attitudes and concerns can be managed to avoid barriers to family business success. Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

Trust and understanding in business-owning families The impact on business transfer

W Barclays Private Bank

ith a huge transfer of wealth between generations fast approaching globally, Barclays Private Bank commissioned research to investigate the relationships between generations of wealthy families, and the factors that influence the effective transfer of family businesses. Certain characteristics and experiences of each generation were found to cause friction, leading to concerns over succession from those looking to transfer their business, as well as those set to inherit. Family businesses were found to often struggle to transfer between generations due to the very same factors that enabled their businesses to become such successes. The ‘originators’ of family wealth were generally very cautious about their business – in many cases, it became an integral part of their identity. They also had concerns about the next generations’ ability to continue the business success. The impact of COVID-19 has further strained succession planning, with many originators changing their business plans as a result of the pandemic. Trust within families is often tested by different business aims and attitudes towards risk, as the younger generation brings new ideas back to the business from their extensive, often international, educa-

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tion. Despite this education, however, those next in line to take over tend to feel underprepared, and often have concerns about how they continue the family legacy. Transparency and preparation are considered the key to long-term family business success. Those from the older generation who founded family businesses, that is, the originators, were cautious about handing over the business to the next generation, often wanting reassurance, having built it from the ground up themselves. The originators typically felt a strong attachment to their business and, in many cases, identified their personal wellbeing with the company. As a result, originators can underestimate the ability of the younger adults in the family. More than half (57%) said that they are concerned about the next generation’s ability to manage the business, and a similar proportion (53%) said that they are concerned about trusting the next generation with the family’s wealth and investments. There was also a belief among almost two in three originators (63%) that the next generation were not as committed to managing the family business as them. As a result, most originators (67%) were highly cautious about relinquishing authority – and, with a natural tendency to stick to the methods that made them successful, originators often maintained a position of authority well into old age. “There is a lot of families that want to start transition to the next

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generation, but they don’t feel that that generation is ready to take full responsibility. The sort of autocracy within families say, ‘I’ve grown most of this wealth. Can you be trusted to take control?’” (Barclays private banker). Despite this cautiousness, many families said that they have shared business ownership between the generations, with 41% of under-40s acting as minority co-owners in a family business. But this ownership was not reflected in the share of decision-making, with 57% of senior family members saying that they remained the only decisionmaker for the business strategy. This desire to maintain positions as controlling decision-makers served their business well for many years but can become a barrier to successful transitions if not understood and managed.

Different attitudes towards risk This issue of cautiousness was compounded by differing attitudes to risk and aims for the family business. Over one in three (35%) of the older generations were concerned that their children would take greater risks when they become responsible for the family business. This concern may be linked to the fact that more under-40s (30%) want to grow family wealth and were less keen to maintain family businesses across generations. Different attitudes towards risk can emerge from competing perspectives, which may be partly due to the prevalence of international education paths among younger generations. Fifty-one percent of under-40s in wealthy families have completed a master’s degree or higher, compared to fewer than one in four (23%) of over-60s. New ideas that younger generations present for family businesses can come from the fresh cultural perspectives their multi-country education provides them, fuelling friction within families, according to almost six in 10 of all generations (from 59% among under-40s to 63% among 40–60-year-olds). “[Under 40s] are benefiting from world-class education, they’re going to the best schools, they’re going to feeder schools for Oxbridge and the other top universities and they’re getting empowered with great knowledge.” (ultra-high-net-wealth intermediary).

Sense of duty but unprepared In this pressured environment, the next generation was anxious about the succession of family businesses and many did not feel fully prepared to take over. Nearly all managers surveyed (94%) expect to take over the family business, but more than one in four (28%) felt that they were or were not prepared to do so. A strong sense of duty tended to exist among secondgeneration managers when it came to their inheritance, with 69% saying that they feel this way. Yet, only just over half of the second-generation managers (53%) said that they received emotional support from the decisionmaker when it came to taking over the family business – a key means of coping with the pressure running a family business can put on succeeding generations.

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Figure 1. Cautiousness among originators

Source: Q50-4. I am concerned about trusting the next generation’s ability to manage the business – To what extent do you agree with the following statement? Base: all participants with a family business – originators (47)

Figure 2. Personal aims

Source: Q10. What are your top three personal aims? Base: all participants, under-40s (151), 40–60-year-olds (158), over-60s (93)

Figure 3. Completed master’s diploma or higher

Source: Q58. Please select the highest degree or level of school you have completed. Base: all participants, under-40s (151), 40–60-year-olds (158), over-60s (93)

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Figure 4. Many wealthy family business ‘managers’ did not feel prepared or supported to take over the business

Sources: Q38. To what extent would you say you were/are expected to take over the family business or assume a senior role? Q40. How prepared do/did you feel to take over the family business? Q39. Thinking specifically about preparing to take over the family business, did you receive any relevant. Base: all participants with a family business – 2nd generation family business ‘managers’ (102)

“There is a need for those discussions with next generations, around, ‘This is what is anticipated and expected’, rather than springing it upon them, because then it gives you a bit of leeway and time to plan.” (Barclays private banker). Preparations, however, require time, and under-40s felt least prepared to take over the family business. This is likely due to fewer years running or contributing to businesses. This feeling existed despite those more extensive levels of education, highlighting the need for experience, not just education. Further, under-40s did not feel that the family business was discussed with them to the same extent as the older generations (54% compared to 69% for over-60s), likely further hindering how prepared they felt. Still, they can expect to be the recipients of at least a significant share of the coming wealth transfer, creating a pressure to achieve when their experience or business planning might not have provided the right tools and support to fulfil this duty.

Impact of COVID-19 Figure 5. How prepared do you feel to take over the family business?

51%

30%

19%

Source: Q40. How prepared do/did you feel to take over the family business? Base: all expecting/expected to take over the family business. Under 40s (101), 40–60 year-olds (100), over-60s (53)

The health risks of the COVID-19 pandemic have brought succession planning into greater focus, as well as creating pressure to adapt ongoing business practices, with 70% of originators saying that the pandemic has affected their business aims, and around two in five (38%) confirming that they were significantly reassessing their financial strategies. As a result, longestablished wealth transfer plans will likely need to be reconsidered to an extent. Much of the effect of COVID-19 on family businesses has been left to be dealt with by those currently managing the ongoing day-to-day activity, who often come from the second generation. Among this group, one in four (27%) said that their aims have changed to primarily manage the negative effect of COVID-19 on their businesses. “Some aspects of the business have slowed or even come to a halt, so adjustments have been made. We’ve also made funding available to help the local community during lockdown.” (second-generation family business manager). Competing aims and pressures were likely to have an impact on family businesses for some time. Taking time to understand how they impact transfer strategies will make the process of transferring businesses smoother.

Overcoming differences The cautious approach of the originators, together with the concern that they felt towards the younger generations’ aims, makes the transfer of family business challenging. Ultimately, this environment could lead to succeeding generations being underprepared and the legacy not being maintained. Recognising these differences through acknowledging and supporting the sense of duty the next generation

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feels about taking over, and being aware of the impact of the current climate, will help families move forward with successful business transfers – as many before them have done. One way these issues can be managed is through a clear understanding of family members’ roles and their aims. Family offices can help by establishing governance around the transfer of businesses and encouraging or formalising greater transparency over what is expected from each family member when it comes to the business. “I think [a family constitution] can lead to better trust being established, because everyone’s agreed the principles around how they’re going to own and manage that wealth as a group.” (private client legal services leader). Through understanding motivations, cultural and generational differences, and the pressure being exerted on families by the current climate, family businesses will be able to avoid the pitfalls into which many before them have succumbed, as the transfer looms. By learning from other sectors and each other, the transfer of wealth can be a successful one. “I think that the private client industry as a whole has got better at encouraging families to be more open, speaking to other families about the challenges of transferring wealth. So, I think then there is a growing amount of transparency and discussions between families around how do you manage this wealth transfer process.” (private client legal services leader). Increased communication and building trust and understanding between generations is vital to achieving positive and successful transfers of family businesses. There are also examples of wealth transfers being done differently, for example, by those in different business sectors, that can help traditional family businesses gain fresh perspectives on how to proceed with their business transfer.

Figure 6. How much have your aims changed due to COVID-19 and current economic situations?

Final thoughts The scale of the upcoming intergenerational wealth transfer means the issue is high on the agenda for numerous families and family businesses. It is a highly emotional time for the families involved, and the current pandemic has shifted the aims of many to make it even more challenging. The differences between the generations mean the process can cause tension and friction. The particularly cautious approach of originators, together with the lack of readiness amongst the next generations, needs to be managed effectively to ensure all involved understand how they are contributing to business success and the perpetuation of legacy. By recognising these issues, looking to examples for guidance, and working together to build trust and transparency within families, the transfer of wealth can be a positive and successful experience.

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32%

42%

33%

Source: Q14. How much have your aims changed due to COVID-19 and current economic situations. Base: originators (78), managers – non-originators but decision-makers (121), shareholders – non-originators and not main decision-makers (203)

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Family Office Management

Research summary This research, ‘Smarter succession: the challenges and opportunities of intergenerational wealth transfer’, was conducted by [data and research firm] Savanta on behalf of Barclays Private Bank and included both qualitative interviewing and a quantitative survey. Qualitative in-depth interviews were conducted with Barclays Private Bank bankers, intermediaries to ultra-high-net-worth families and Barclays Private Bank clients themselves. In total, 20 interviews were conducted – banker and intermediary interviews taking place in March 2020, and client interviews in June 2020. In addition, a quantitative survey was conducted with individuals

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from very-high-net-worth families (total net worth of more than £5 million). A total of 402 interviews took place across three generations of wealthy family members including: under-40s (151), 41–60-yearolds (158) and over-60s (93). Two-hundred and ninety were male and 112 female. Participants are primarily living in France, Germany, Hong Kong, India, Italy, Qatar, Saudi Arabia, Switzerland, Singapore, the UAE, and the UK. Family business owners totalled 290 within the sample. Across the whole sample, 78 identified themselves as wealth originators, 121 as non-originators but main decision-makers (managers), and 203 as non-originators and not main decision-makers (shareholders). fs

CPD Questions Earn CPD hours by completing this quiz via FS Aspire CPD. 1. Which statement best describes the wealth originators or founders of family businesses? a) The majority have attained a tertiary qualification b) They identity their personal wellbeing with the business c) They are more willing to take risks than future generations to grow family wealth d) They actively share their business know-how and encourage joint decision-making 2. Why did many under-40 family members feel least prepared for taking over the family business? a) Presence of older siblings who were ‘first in line’ for succession b) Fewer years of contributing to the business c) Inadequate life experience d) Lower levels of emotional attachment to the family business 3. Over 65% of wealth originators were highly cautious over relinquishing authority over their business. a) True b) False

4. The next generation, or next in line to take over family businesses, typically: a) Hold concerns over how they will maintain the family business b) Are extremely confident over their ability to take over the business c) Keep their emotions in check during the transfer to minimise family disruptions d) Are overprepared for the transfer, owing to strong inter-family bonding 5. According to data cited, maintaining the family business across generations was the most identified goal for: a) Over-80s b) Under-60s c) Over-60s d) Under-40s 6. Responsibility for dealing with the impact of COVID-19 upon family business has primarily fallen to secondgeneration business managers. a) True b) False

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www.fsprivatewealth.com.au Volume 10 08 Issue Issue04 01 || 2019 2021

Taxation & Estate Planning:

Leaving a gift to a charity that no longer exists

By Geoff Milani, Elringtons Lawyers

Taxation & Estate Planning

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CPD Earn CPD hours by completing the assessment quiz for this article via FS Aspire CPD. Worth a read because: Charitable gifts in Wills can have unforeseen issues such as charities amalgamating, winding up, or being described incorrectly. This paper highlights contingency plans and redress measures for such situations. Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

Leaving a gift to a charity that later no longer exists

M Geoff Milani

any people generously leave gifts to charities in their Wills to support the community or important causes. Unfortunately, these gifts sometimes run into issues when the charities named in the Will amalgamate with other charities, are wound up, or where the charity is not described correctly. It is possible for these charitable gifts to still take effect. However, it depends on why the gift lapsed, as well as the gift’s wording. Ideally, the Will should contain a clause giving the executor the power to select a similar charity, avoiding the estate from incurring expenses trying to resolve the issue. Where the Will does not contain a clause giving the executor the power to select a similar charity, the executor may need to make a cy-pres (pronounced sigh pray) application. This is a request to the Attorney-General or Supreme Court requesting they intervene and redirect the gift to an appropriate charity.

How can a gift to a charity fail? There are several ways a gift to a charity may fail or lapse. These include the following situations: • The charity named in the Will has amalgamated, and is now a new entity. • The charity named in the Will has wound up, and no longer exists. • The charity was named or described incorrectly in the Will.

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Because the charity no longer exists (at least in the same form), or ‘never’ existed if it was incorrectly named, the gift needs to be able to pass to someone else. An example of this is demonstrated in Gray v Australian Cancer Foundation for Medical Research [1999] NSWSC 492. The deceased left most of his estate to ‘the Cancer Research Foundation’. His Will was made in 1984, with a gift to the same charity also appearing in his previous 1979 Will. An issue arose because no charity existed known as ‘the Cancer Research Foundation’. Three charities claimed they were entitled to the gift, namely the: • Australian Cancer Foundation for Medical Research, which was incorporated in 1984, and later changed its name to the Australian Cancer Research Foundation. • University of Sydney, as the Melanoma Foundation. • Cancer Council. The Supreme Court found that the history of the charities’ names, community awareness of the charities, and the history of the deceased’s previous Wills, meant that none of those claimant charities were whom the deceased was referring to when he named ‘the Cancer Foundation’. The court then distributed the gift by cy-pres.

What can happen when a gift to a charity fails? Depending on the circumstances, there are two ways a charitable gift can be dealt with when the charity no longer exists or has been described incorrectly. Where the gift was made to a charity in its own right,

and not for its charitable purposes, the gift will fail and the funds dealt with through the residuary estate (part of an estate not allocated to someone in a Will or accounted for). If the gift to a charity was as part of the residuary estate, the funds will instead be dealt with through intestacy (conditions if someone dies without having made a valid Will). Where the gift was made to a charity for its charitable purposes, the gift will be dealt with by cy-pres. This allows the gift to be ‘redirected’ towards another charity with similar purposes as that named in the Will.

What is cy-pres? Cy-pres is, in effect, a legal safety net to ensure a charitable gift does not fail just because the charity named in the Will no longer exists or (in certain instances) has been incorrectly named. Cy-pres allows either the Attorney-General or Supreme Court to intervene to direct the charitable gift towards a charity with a similar purpose to that named in the Will. In other words, to quote the High Court in AttorneyGeneral (NSW) v Adams (1908) 7 CLR 100, 125, cy-pres permits the charitable gift to: “… carry out the general paramount intention in some way as nearly as possible the same as that which the testator has particularly indicated without which his intention itself cannot be effectuated”. In NSW, to be eligible for cy-pres, a gift to a charity must have been given with a general charitable intention, as opposed to having been given to the charity in its own right (Charitable Trusts Act 1993 (NSW) (Charitable Trusts Act) section 10(1)). For example, if a gift is given to the National Cancer

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Geoff Milani, Elringtons Lawyers Milani is a solicitor at Elringtons Lawyers. Previously, he worked for the Public Trustee of Tasmania. He practises in the areas of estate planning, property and commercial law. He acts for a broad range of clients including individuals and families, small to medium businesses, and not-for-profits.

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Taxation & Estate Planning

Foundation, that gift is given with a charitable intention if it was for the purpose of the National Cancer Foundation using the money for cancer research. This is in contrast to a situation to whether the gift is given to benefit the National Cancer Foundation in its own right, separate from its role in cancer research. There is a presumption in New South Wales that any gift made to a charity is made with a general charitable intention (Charitable Trusts Act section 14(1)(a)). The Attorney-General has jurisdiction over cy-pres applications in NSW up to gifts of $500,000 (Charitable Trusts Act section 10(2)). Amounts exceeding that threshold, or complex estates, are referred to the Supreme Court for resolution (Charitable Trusts Act section 14(1)(b)).

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What precautions should be taken? If you leave a gift to a charity in your Will, it is important that the Will contains a savings provision for incorrect or defunct charities. This allows your executor to select a substitute charity with similar purposes to the charity named in your Will. In effect, this sort of savings provision acts as an inbuilt cy-pres mechanism and saves your executor, and your estate, from the expense of applying for a cy-pres scheme from the Attorney-General or Supreme Court. fs Disclaimer: This article is general in nature. It is intended only to provide a brief summary of some issues to consider when making charitable gifts in Wills. This article is not a substitute for proper personalised legal advice.

CPD Questions Earn CPD hours by completing this quiz via FS Aspire CPD. 1. Which of the following outcomes was achieved in Gray v Australian Cancer Foundation for Medical Research? a) The executor to the Will selected a similarly purposed substitute charity to receive the funds b) The Supreme Court distributed the gift by way of cy-pres c) The gift lapsed and the funds were dealt with through the deceased’s residual estate d) The gift was directed to the charity with most similar name to the charity named in the Will

4. To what does the term cy-pres refer? a) A legal safety net to ensure a gift does not fail due to incorrect naming in a Will b) A court order directing a failed charitable gift to another charity of similar purpose c) The power held by an executor to nominate a substitute charity d) A legal safety net to ensure a gift made to a charity in its own right does not fail

2. In the event of a failed gift that is given with a specific charitable intention but to a charity that no longer exists: a) The gift will be dealt with according to statutory intestacy rules b) It cannot be dealt with by way of a cy-pres application c) It will be redirected to another charity with a purpose similar to that named in the Will d) The gift will be dealt with through the individual’s residuary estate

5. What precaution can any individual take to improve the chances of successfully gifting to their preferred charity or cause? a) O nly gifting to longstanding charities with proven financial structure and support b) Including a signed and witnessed application for cy-pres in their Will c) Only gifting to a specific-named charity in its own right within their Will d) Including a savings provision for incorrect charities within their Will

3. A residuary estate is that part of an estate remaining unallocated in a Will. a) True b) False

6. Under NSW law, any gift made to a charity is presumed to be made with a general charitable intention. a) True b) False

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www.fsprivatewealth.com.au Volume 10 08 Issue Issue04 01 || 2019 2021

Compliance:

Resolving and preventing shareholder disputes

By Kayleigh Yap, Sprintlaw

Compliance

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CPD Earn CPD hours by completing the assessment quiz for this article via FS Aspire CPD. Worth a read because: Negotiation and compromise are often preferable for resolving shareholder disputes. However, it pays to understand the legal proceedings pathway and court approach to such matters and be able to assess the merits of various dispute resolution outcomes. Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

Resolving and preventing shareholder disputes

Y Kayleigh Yap

ou and a friend have come up with a brilliant idea that you reckon will be a great business venture. So, you set up a company, where you both own 50% of the company as shareholders and are appointed as directors. You know each other well and you want to get the business up and running as soon as possible. There is no need for a shareholders agreement – it is just a formality, right? You both share the same interests and goals now, but what happens if these change down the track? This could happen for any number of reasons; maybe you want to focus on your family, or it might even be that you feel like you are putting in more time and effort into the business than your friend. Shareholders agreements are an important contract that can save your business a lot of time, effort and money. They outline how decisions are made, what happens if you or another shareholder decides to leave the company, and dictate how disputes should be dealt with.

Key terms Understanding the terminology relating to shareholder disputes can be useful for working out your options. A shareholder is an owner of a company. They are in control of the company and have the power to elect directors. In contrast, the director of a company is in charge of managing the day-to-day affairs of the company. When it comes to small busi-

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nesses, it is quite common to see one person holding both the role of shareholder and director. It is also helpful to understand the distinction between a company’s constitution and a shareholders agreement: • A company constitution lays the ground rules for how the company will operate (for example, what the directors’ powers and duties are, how to hold meetings and vote). • A shareholders agreement is geared towards outlining the rules around the relationship between shareholders and directors, as well as how to deal with money and other company capital.

Resolving shareholder disputes So, what happens if a dispute arises between shareholders? Let us explore what happens for 50/50 shareholders and minority shareholders.

Resolving disputes between 50/50 shareholders What happens if you and your friend do not see eye to eye on a business matter or decision? The best outcome would be to negotiate a solution that everyone is happy with and lets you stay friends. Of course, there may be situations in which this cannot be achieved, especially if your company constitution or shareholders agreement does not outline a clear dispute resolution process. You may be surprised to find out that you cannot force your friend – or any other shareholder – to sell their shares just because there has been a disagreement.

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Explore negotiation If you and the other shareholder are willing to come to a compromise, negotiation is often the preferred avenue of resolving a shareholder dispute. This is because it tends to be quicker and cheaper than taking the matter to court. The outcome of negotiation will differ according to your situation and what you and the other shareholder want, so it is important that you consider what your best- and worst-case scenario is before commencing negotiations. Kayleigh Yap, Sprintlaw

If neither you or the other shareholder wishes to continue operating the business, there are two main options: 1. Splitting the business’s assets. 2. Selling shares (this can be from one shareholder to the other, to a third party, or back to the business).

Splitting the business’s assets in a shareholder dispute Negotiating and splitting the assets can be useful if you wish to continue using any of them in the future. For example, if you created any intellectual property for the business, you may wish to retain it for a new business.

Selling shares in a shareholder dispute If one shareholder wishes to continue to operate the business, the other shareholder could sell their shares – either to the remaining shareholder or to a third party. A company buyback may also be arranged. If it looks like a sale of shares could take place, it may be useful to have the company and shares assessed independently to avoid any disagreement or argument over their value. Where a shareholder wishes to sell their shares to a third party, it is important to make sure that they find a buyer who brings something valuable to the business. Some company constitutions may enable the remaining shareholder to refuse the transfer of shares to a proposed new shareholder, so it may be helpful to read over and review your own company’s constitution for any relevant clauses. A company may also buy back shares from the departing shareholder, so long as there is nothing in your company constitution that prevents it. According to section 257A of the Corporations Act 2001 (Corporations Act), a company has the power to buy back shares if: • The sale does not impact the company’s ability to pay its creditors, and • The buyback complies with the procedures outlined in Part 2J.1 Division 2 of the Corporations Act. A company buyback can be difficult as it involves complex processes that often depend on how many shares are being sold. Seeking professional legal help in this situation is recommended to make sure all bases are covered.

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Court proceedings Unfortunately, negotiation may not always work and you may be thinking about going to court. Initiating court proceedings should be treated as a last resort. Not only do they cost a lot of time and money, the court is also limited in what orders it can make, and it may result in an outcome that neither party is happy with. In addition, the process may worsen your relationship with the other shareholder. What started as a great friendship may ultimately come to a bitter end.

Yap is a graduate in arts and law from UNSW. With an interest in human rights and intellectual property law, she has experience working in law, marketing and communications for not-forprofits and small businesses.

Courts will not hear matters simply because you and the other shareholder have a disagreement or dispute. Rather, you will need to start proceedings according to certain criteria. Some common examples include, but are not limited to, the following: 1. Breach of a director’s duty Directors have four main duties: • To act with due care and diligence • To work in good faith • Not to improperly use their position • Not to use information improperly. 2. Applying to wind up the company According to section 461 of the Corporations Act, courts mayorder that a solvent company be wound up if it found to be “just and equitable”. This will only happen in very limited circumstances, especially if there are employees who will be impacted by the order. But what does it mean to be just and equitable? Looking at the circumstances of the dispute, the court will ask whether it is so serious that the only way to resolve the deadlock would be to wind up the company and bring its existence to an end. This is sometimes more relevant with small businesses and companies founded by friends because the relationship between the two shareholders is often built on mutual trust and confidence. 3. Oppressive conduct This is discussed in the next section.

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Compliance

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Resolving minority shareholder disputes

CPD Questions

If you are a minority shareholder, it is worthwhile knowing about oppression and what actions could constitute oppressive conduct under Part 2F.1 of the Corporations Act. Oppression is defined in section 232 of the Corporations Act:

Earn CPD hours by completing this quiz via FS Aspire CPD 1. Li and Al are 50/50 shareholders in a company. After a disagreement, Li wants out. They have no formal dispute resolution measures. Which of the following statements is correct? a) Li is not obligated to sell her shares b) Al can force Li to sell her shares c) They must pursue negotiation as an initial remedy d) The company and shares must be assessed independently 2. The author highlights that as a means of resolving deadlocked shareholder disputes, courts: a) Treat wind-ups as a last resort b) Rely on the criterion of “just and equitable” regarding wind-ups c) Need disputing parties to meet certain pre-proceedings criteria d) All of the above 3. A company can buy back shares from a departing shareholder: a) Only if a remaining shareholder purchases the shares b) Irrespective of the company’s constitution c) If the company’s constitution does not prevent this d) Only if a third party purchases the shares 4. Which of the following statements regarding oppressive conduct in relation to minority shareholders is correct? a) It can apply to a breakdown in shareholder relations b) It must be a repeated behaviour, not a one-off occurrence c) It can apply to disagreements on how to run a company d) It needs to demonstrate a lack of fair dealing 5. The author believes that in relation to shareholder disputes, asset splitting can work well for new business ventures. a) True b) False 6. According to the author, company buybacks are a relatively straightforward way to settle shareholder disputes. a) True b) False Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

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The Court may make an order under section 233 if: (a) the conduct of a company’s affairs; or (b) a n actual or proposed act or omission by or on behalf of a company; or (c) a resolution, or a proposed resolution, of members or a class of members of a company; is either: (d) contrary to the interests of the members as a whole; or (e) oppressive to, unfairly prejudicial to, or unfairly discriminatory against, a member or members whether in that capacity or in any other capacity.

Oppressive conduct may comprise either a single act or a pattern of behaviour, as long as there is a demonstrated lack of fair dealing, and which oppresses the minority shareholder. Some examples of oppressive conduct include: • Refusing the minority shareholder access to information about the company’s affairs. • The unfair allocation of, or restrictions on, the payment of dividends. • Using company funds for improper purposes. • Denying other directors the ability to carry out their own functions and duties. It is important to note that oppression cannot be used as a tactic to further your own interests and is not applicable in circumstances where there is a disagreement on how to operate the company or a breakdown in the shareholders’ relationship.

Avoiding escalation Preventing shareholders disputes is generally much more effective and cheaper than finding a cure. Talking to a lawyer can provide a good foundation for making sure your business has dispute resolution processes set up and ready to go. You may also want to check that your other legal documents – such as your company constitution or shareholders agreement – are up to scratch. It is important that these are drafted properly to save you and your business unnecessary headaches if a shareholder dispute does arise. fs Founded in 2017, Sprintlaw is a new type of law firm that operates completely online and on a fixed-fee basis. Its mission is to make quality legal services faster, simpler and more affordable for small business owners and entrepreneurs.

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Ethics & Governance:

Risky board business

By Omer Soker, Association Impossible

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CPD Earn CPD hours by completing the assessment quiz for this article via FS Aspire CPD. Worth a read because: Association board members may be tempted to encroach on operations, not pull their weight or avoid painful decisions. Chief executives can counter such behaviours through good governance initiatives like setting clear boundaries, guidelines and expectations. Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

Risky board business The future of associations

D Omer Soker

ifferences in perspectives between boards and chief executives can undermine the quality of their relationships. Unaddressed, opposing viewpoints can escalate quickly. The title of an early Tom Cruise mega-movie sums this up perfectly – Risky Business. The trust between chair and their chief executive is paramount. If trust breaks down, it can divide a board or separate management from the board and, in that instance, someone has to go. It might well be the chief executives if they are not performing, but the chair also needs to look inward sometimes. If the chief executive is performing well and has the support of the board and the leadership team, the chair needs to make a difficult decision and step down. So, what are the biggest strains on the chair-chief executive relationship, and how can they be managed so that it does not come to this? How can these potentials for negativity be transformed into positive change that unites them towards a successful future? The complaints chief executivess make about chairs or boards are often expressed around the water cooler at association industry conferences, when they get a chance to compare experiences with their peers. It is not a topic covered in keynote presentations but confined to informal off-the-radar gatherings where chief executive’s can find their experiences of inappropriate board behaviour may be widespread across diverse sectors. The purpose of bringing these conversations out into the open is

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to enable this behaviour to be mitigated – from either side. Both chief executives and chairs share a responsibility to move towards solutions, although it is the chair’s role to bring the board into line. So, what are the top water-cooler grievances chief executives have about risky board behaviour?

1. Strategy – not operations Untrained, some board directors may not know the difference between strategy and operations, especially if they have not worked in large strategically focused organisations. Small business operators may switch between strategy and operations at will, but board directors have a responsibility not to. The board’s role is clear, and it does not extend to operations. Strategy is setting the direction of the association, devising objectives and identifying a range of strategies to pursue – and then monitoring progress towards them. Operations refer to the management and administration of business practices within the association, and are beyond the board’s remit. The lines are clear and need to be respected. While it may be natural to stray into operational matters, it is the chair’s role to ensure this does not happen, or to put into place a separate process outside of board meetings for any operational suggestions to be put forward. The chief executive can then view these as suggestions only, not as dictates. Directors wasting precious board meeting time on operational matters ranks top of the list for many chief executives as a major cause of frustration. It is an unhelpful distraction from the important

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discussions the board needs to have and a counterproductive intrusion into the chief executive’s role. It breaks down trust, clarity and professionalism. Directors wanting to help can cause more problems if their input is not channelled through the right processes and in appropriately designated areas. When the entire board focuses on strategy instead of operations, everyone wins.

2. Monitor – not meddle Passionate boards can think their roles are to help staff, lend their expertise, or get involved in management. Nothing could be further than the truth. The board is there to lead, but not manage the association. Its remit is to monitor the chief executive and the association’s progress, but not to meddle in its management. Chief executives are justified in this water-cooler complaint, which they see as the board’s encroachment on their management responsibilities. Good governance makes the separation of powers clear. Everyone has a job to do and must be empowered to do it – if it is to be done well. So, what constitutes meddling? Water-cooler chief executives say that it is primarily the board’s access to influence or direct staff, or interfere with the actual process of management. Meddling is when directors make operational suggestions and then act on them. Association employees have easier access to their board directors than their commercial counterparts. The upside is that boards can gain more visibility to the culture of the association. The downside is that this exposure can lead to board directors exerting undue influence or pressure on employees, who may not have the training or skills to resist. This makes it difficult for employees to prioritise, which is why the filter of the chief executive is critical. In meddling with staff, board directors undermine the authority of the chief executive and the leadership team, and create an unstable environment. With lines of reporting breached, staff can find themselves without direction and confused about where to turn for leadership and guidance. Professionally competent chief executives may find it difficult to tolerate boards meddling in operational management issues because it restricts them from being able

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to perform their own roles diligently and effectively. The chief executive necessarily looks to the board for support and guidance on strategy, governance and risk management. Without it, they are already hampered. Boards meddling in operational matters only make things worse for everyone. This includes the chief executive, the employees and ultimately the association and its members. Similarly, chief executives who passively condone meddling boards accelerate the damage to all stakeholders.

3. Professional – not social focus The board is there to do an important job, and requires a consistently professional focus. It is not a social club or a fellowship of mates. Camaraderie is essential, but it is not the objective – it is a pleasurable means to an end. What are the gripes of chief executives in this respect? One of the most common is directors who do not read their board papers, come unprepared for meetings or fiddle with their phones during board discussions. If they were in kindergarten, the teacher would put them in the naughty corner for sure. Anything less than professional courtesy is dismissive of the power directors hold over the association, and disrespectful to any employees attending the meeting. Directors need to come prepared, be attentive, make a direct contribution and ask insightful and challenging questions to raise effective discourse. Board directors who do not say a word during board meetings or contribute in other ways throughout the year except to vote on resolutions should come under scrutiny. Some are happy to be flown in and accommodated at hotels to enjoy the fun of board dinners, the company of their peers and the kudos of their directorships. But what value do these individuals bring? Proper evaluation of all board directors is required so that their contribution is clear, otherwise these ‘sitting members’ need to move on. Some chief executives have admitted to retaliating with long, tedious board papers. This is not the solution. chief executives have a duty to ensure that board papers are clear and succinct, are not designed to keep the board in the dark, and do not take a combative stance. In return, boards should not take a dictatorial position, which is equally unconstructive.

Omer Soker, Association Impossible Soker is founder of Australiabased Association Impossible. He has worked with hundreds of associations as a strategist, and successfully transformed two membership organisations as chief executive officer. Omer is the author of The Future of Associations. His proprietary 6-Step Roadmap to Progress, Change & Influence provides a strategic framework for the development of membership organisations. He is also a professional speaker and facilitator.

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4. Difficult decisions – not easy avoidance

CPD Questions Earn CPD hours by completing this quiz via FS Aspire CPD 1. In terms of good governance, the author believes that boards should: a) Become mentors and helpers of staff b) Take the reins and manage an association c) Avoid operational management matters d) Counteract chief executive filtering initiatives 2. What dos the author recommend for addressing possible chief executive-chair relationship strains? a) Limit complaints to informal channels b) Bring grievances out in the open c) Accept that trust is too abstract a concept d) Avoid comparing experiences with peers 3. New association board member Jo is unsure how to cement her position. How would you advise her? a) Participate actively in meetings b) Encourage the use of detailed board papers c) Defer to long-serving members in meetings d) Prioritise the social aspect of interactions 4. What action does the author recommend to enhance board-association collaboration? a) Be accountable b) Seek alignment c) Excel at the basis d) All of the above 5. What does the author think boards should do in relation to difficult decisions? a) Pursue harmony over conflict b) Face tough issues head-on c) Use neutral parties such as consultants d) Maintain stability over change 6. According to the author, open debate: a) Helps quash contrary time wasting b) Counters biases and hidden agendas c) Is less of a concern for associations d) Though necessary, will frustrate chief executives Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

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Water-cooler chief executives bemoan boards that are uneasy about confronting problems in the hope they will go away, and reluctant to make difficult decisions. Their thinking is validated by some management consultants who suggest that volunteer boards generally prefer an easy life, and want to see things ticking over nicely on the surface rather than tackling the underlying problems. If this is true, consultants need to earn their keep and advise boards very differently. Governing is hard and includes difficult choices on difficult issues. If an association is to move forward, it cannot avoid confronting tough or unpopular decisions. Doing so undermines progress. There will always be resistance to change. Boards that try and avoid issues of conflict in an attempt to please everyone will inevitably fail. Doing what is right is never easy, and boards must hold their nerve. They need to steer their associations assertively towards mission, vision and objectives – and empower chief executives to overcome the hurdles and challenges in the way.

5. Open debate – not hidden agendas Chief executives reporting to boards that do not encourage open, robust debate can find themselves frustrated. Open debate is how organisations think. It is as true for associations as it is for corporates or government in enabling better decision-making. Discussing options proactively from different or conflicting viewpoints helps identify and weed out potential weaknesses. Logical, passionate arguments help determine the best outcomes for the greater good. The opposite of active debate is passive silence. It increases the risk of personal preferences creeping into board discussions from dominant personalities. Unchallenged by a robust board process for debate, it becomes easier for biases and hidden agendas to take hold. In these instances, professional chief executives look to their chairs to uphold good governance. Encouraging healthy, respectful debate is an effective method for ideas to be shared, communicated and negotiated within a group dynamic. It allows contrary thoughts to be considered in order to develop the optimum strategy with which to move forward. Diversity of thinking is the basis of continuous improvement and innovation. Boards must create an environment where directors and chief executives can speak up freely with respect, fairness, objectivity, truth and transparency.

6. Other indiscretions? By the time conferencing chief executives get to this point, the conversation has probably moved from the water cooler to the bar, and needs to end. Ideally, chief executives need to work collaboratively in the best interests of their associations. This may take some reflection, so here are eight priorities that apply equally to chief executives and employees as they do to boards. • Serve the members, not individual preferences. • Be accountable and take personal responsibility. • Look for alignment, not silos. • Stick to the strategy, do not flip flop between whims. • Do the core well and the basics brilliantly. • Do not expect privileges or preferential treatment. • Do not settle for the status quo, but ignite progress. • Never stop learning and keep contributing to good governance. fs

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Investment:

Intangible assets: What’s easy versus what’s right

By Savina Rizova, Dimensional

Investment ideas for the next 12 months

By Yoram Lustig and Michael Walsh, T. Rowe Price

Investing in esports and video games

By VanEck

Addressing housing affordability in Australia

By Matthew Tominc, ‎Conscious Investment Management

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CPD Earn CPD hours by completing the assessment quiz for this article via FS Aspire CPD. Worth a read because: It is easy to make a connection between value stock underperformance and intangibles. Thus, investors would do well to avoid noisy estimates of internally developed intangibles and instead incorporate externally acquired intangibles reported on balance sheets. Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

Intangible assets What is easy versus what is right hile the value premium is established by valuation theory and research spanning multiple decades and countries as a robust long-term driver of expected stock returns, it is volatile and can go through long periods of negative returns. In fact, we are in such a period right now. The recent underperformance by value stocks has promoted many value investors to start soul searching. With a hindsight into what types of companies drove the outperformance of growth stocks in recent years, it is easy to draw a connection between the underperformance of value stocks and intangibles. As a result, we have heard a lot of claims that investors need to adjust value measures for intangible assets which are not fully reported on the balance sheet.

The difference in accounting treatment is primarily due to the higher uncertainty around the potential of internally developed intangibles to provide future benefits and the difficulty of identifying and objectively measuring such benefits. After all, internally developed intangibles do not go through a market assessment, while externally acquired intangibles get evaluated in the competitive market for mergers and acquisitions, and at that time, they might already be generating tangible benefits for the company that developed them. As an example, consider the Star Wars franchise. Lucasfilm, the company set up by the movies’ creator George Lucas, spent years building and benefiting from the franchise as an unreported internally developed intangible asset. In 2012, Disney bought the franchise, making it an externally acquired intangible asset that was capitalised on the firm’s balance sheet.

Are intangibles on the balance sheet? Yes and no

Are intangibles growing in importance? Yes and no

Many companies earn revenue from intangible assets such as patents, licences, computer software, branding, and reputation. There are two types of intangible assets – externally acquired and internally developed. Under United States accounting principles, externally acquired intangibles are reported on the balance sheet. In contrast, internally developed intangibles are generally not capitalised on the balance sheet. They are expensed, and thus reflected on the income statement.

Externally acquired intangibles, the ones reported on the balance sheet and reflected in valuation ratios such as price-to-book equity, have grown over time relative to firm assets (Figure 1). Since internally developed intangibles are not on the balance sheets, one has to estimate their value in order to say something about their evolution. Several academic studies do that by accumulating a firm’s spending on research and development (R&D) and a portion of its spending on selling, general, and administrative expenses (SG&A).

Savina Rizova

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Using this approach, Dimensional has found that internally developed intangibles have not meaningfully increased as a proportion of total assets. Over the last 40 years, they have represented about 30% of company assets, and over that period there was a healthy value premium. This undermines the argument that the underperformance of value in recent times is driven by value metrics not fully capturing intangibles.

Would adjusting for intangibles improve the pursuit of value and profitability? Yes and no

unadjusted metrics tend to be smaller when we account for differences in sector allocations and interactions between the premiums. Therefore, incorporating estimates of internally developed intangibles into a systematic investment process that already accounts for the interactions of premiums and manages sector diversification is likely to introduce multiple sources of noise without meaningfully improving expected returns. Savina Rizova, Dimensional

The estimation approach for internally developed intangibles contains a lot of noise due to the necessary assumptions and the quality and availability of data. For example, only half the US market reports R&D data, so the estimated knowledge capital for about half of the US market is zero. Thus, we would adjust the value and profitability metrics of half of the market for knowledge capital and leave the rest unadjusted. The estimation approach can also produce noisy results because it applies constant amortisation rates through time and does not allow for impairments. As a result, a company can be approaching bankruptcy and still appear to have billions of dollars’ worth of internally developed intangibles. Because of all those different sources of noise, we find that estimated internally developed intangibles contain little additional information about future firm cashflows beyond what is contained in current firm cashflows. Moreover, we do not find compelling evidence that capitalising estimated internally developed intangibles yields consistently higher value and profitability premiums. Adjusting for internally developed intangibles, the value premium gets a little larger, while the profitability premium gets a little smaller. The differences in the value and profitability premiums between adjusted and

Rizova is Dimensional’s global head of research. She applies her background in finance to a wide variety of research projects to improve every step of Dimensional’s investment process, from research on drivers of returns to portfolio design, portfolio management, and trading. She holds a PhD in finance, an MBA and a BA in economics and mathematics.

Figure 1. Evolution of on- and off-balance sheet assets relative to total assets, 1963–2018

0.8

Internally Developed Intangibles-to-Assets Externally Acquired Intangibles-to-Assets PP&E-to-Assets

0.6 0.4 0.2 0.0 1963

1968

1973

1978

1983

1988

1993

1998

2003

2008

2013

2018

The weighted average characteristics are evaluated annually at the end of June, assuming when the data are missing. Total assets are adjusted for internally developed intangibles. PP&E (property, plant and equipment) is net of accumulated depreciation. Source: Dimensional

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Investment

Given the large challenges with estimating internally developed intangibles, an alternative approach to more effectively infer differences in expected returns among firms with different sources of intangibles might be to strip out externally acquired intangibles from the balance sheet. However, our empirical analysis shows no compelling performance benefit to excluding externally acquired intangibles from fundamentals.

The easy thing versus the right thing The recent strong performance of some growth companies with a lot of intangibles might imply a relation between intangibles and the value premium. The easy thing to do is to immediately adopt an intangibles adjustment, hoping it will ‘kill the pain’. However, the right

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thing to do is to rigorously evaluate the impact of such an adjustment. Our research indicates that investors are better off continuing to incorporate externally acquired intangibles reported on the balance sheet and not adding noisy estimates of internally developed intangibles to value and profitability metrics. We believe systematic investing should be based on sound financial theory and robust empirical research. Value investing is based on the premise that paying less for a set of future cash flows is associated with a higher expected return. That is one of the most fundamental tenets of investing. Ample empirical evidence on the value premium shows that value investing is a reliable way for investors to increase expected returns. But no one has said it is going to be painless. Further, adjusting for intangibles might hurt more than help with that pain. fs

CPD Questions Earn CPD hours by completing this quiz via FS Aspire CPD. 1. Which of the following was identified as a failing to an estimation approach for internally developed intangibles? a) The fact that internally developed intangibles are no longer rising as a proportion of total assets b) Only 50% of the US market reports R&D data c) Significant value can be placed on internally developed intangibles despite a company facing bankruptcy d) The approach applies variable amortisation rates through time

4. How are internally developed intangible assets treated under US accounting principles? a) They are excluded from all company financial accounts b) They are expensed and recorded on the income statement c) They are capitalised and reported on the balance sheet d) They are expensed and recorded on the balance sheet 5. What conclusion does this paper reach regarding

2. Within company accounts, externally acquired intangible assets are: a) Reported on the balance sheet and included in company valuation ratios b) Estimated in value and so excluded from company balance sheet c) Reported on both the company balance sheet and income statement d) Typically expensed but not capitalised on the balance sheet 3. Value investing is based upon the premise that higher expected returns can be earned by paying less for a specified set of future cashflows. a) True b) False

adjusting for internally developed intangibles in a systematic investment process? a) It would significantly enhance the overall value premium b) It would meaningfully improve expected returns to investors c) It would be preferable to strip out all intangible assets from the investment process d) It could create issues that outweigh any gains in profitability for investors 6. The Star Wars franchise is treated as an unreported internally developed intangible in the accounts for Disney. a) True

b) False

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CPD Earn CPD hours by completing the assessment quiz for this article via FS Aspire CPD. Worth a read because: This paper identifies five key themes set to drive economic and market performance over the coming 12 months and beyond. In this context, it proposes effective investment strategies, assesses certain investment styles, and discusses geopolitical risks and investor behaviours during COVID-19. Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

Investment ideas for the next 12 months Positioning portfolios for challenges and opportunities

Yoram Lustig and Michael Walsh

he year 2020 proved to be particularly challenging for investors as the COVID-19 pandemic upended growth expectations and generated unprecedented policy responses. Investors will remember 2020 with mixed emotions. On one hand, it was the year of the catastrophic COVID-19 pandemic, with its devastating human and economic tolls. On the other hand, it was a year that delivered strong positive returns across a wide range of financial markets – an extraordinary outcome, given the destructive economic backdrop. Against such wildly contrasting dynamics, what lies ahead for 2021, and how might investors position their portfolios in response?

Trying to imagine the future is a difficult task in normal times. As the times we are living through are anything but normal, marked as they are by a very high degree of uncertainty, identifying the likely direction of events is even more challenging. Nonetheless, we have identified five key themes we believe will drive the performance of economies and markets over the coming 12 months and beyond: 1. Post‑pandemic road to recovery 2. Politics and the pandemic 3. Policy and low yields 4. Parting styles amid disruption 5. Pricey safety. As these dynamics play out, we have identified a range of investment ideas we believe may be effective in helping to navigate the period ahead.

Investment idea 1. Post-pandemic road to recovery Investment idea

Offence and defence

Procyclical assets

Active management

Rationale

When uncertainty is elevated and markets are choppy, balance return-seeking and defensive assets to navigate volatility and ensure true diversification.

Procyclical assets tend to outperform during economic recovery. Some of these assets have lagged in the 2020 rally in risk assets, so their valuations may be attractive.

Volatility and change cause prices to diverge from valuations. This is an environment for skilled active managers to add value, in particular when some valuations are rich.

Examples

• O ffensive assets (e.g. stocks, corporate bonds, high-yield bonds, emerging market debt) • Defensive assets (e.g. high-quality long-dated duration, safe-haven currencies, defensive strategies).

• Small-capitalisation stocks • Credit markets.

• Active managers with proven track records • Fundamental-driven security selection and tactical asset allocation that can adapt to new conditions rather than relying on past behaviours.

Source: T. Rowe Price

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1. Post‑pandemic road to recovery

Yoram Lustig, T. Rowe Price Lustig is T. Rowe Price’s head of multi-asset solutions, EMEA. Previously, he was head of multiasset investments UK at AXA Investment Managers, head of multi-asset funds at Aviva Investors, and head of portfolio construction EMEA at Merrill Lynch.

Michael Walsh, T. Rowe Price Walsh is a London-based solutions strategist in T. Rowe Price’s multiasset solutions team for EMEA. Previously, he worked at UBS Asset Management within its investment solutions business.

The pandemic is impacting markets in multiple ways. One is through its effect on the global economy – both in terms of the current slowdown and the eventual shape of the recovery. We believe the economy will continue to mend, but the recovery is likely to be choppy, potentially including a double‑dip contraction. Then, we hope, will we commence a slow return to some normality. A second way in which the coronavirus is affecting markets is through its impact on behaviours. Policymakers appear set to do whatever they can to stimulate the economy, but corporations and consumers may remain cautious if the economic hardship drags on and the pandemic gets worse before it gets better. As we have seen during 2020, sentiment may pulse with bursts of optimism and pessimism, adjusting to rising and falling rates of infection, government efforts to control outbreaks, and news about vaccines. One certainty is uncertainty. Professional investors are trained to make sense of finance and economics, not of viruses and epidemiology. With this in mind, our first investment idea in this theme is to split portfolios into return‑seeking and conservative assets. When markets are driven by unfamiliar factors and emotions, portfolios should balance offensive and defensive characteristics to benefit from any upsides and protect against downsides. Our second investment idea is to include procyclical assets in portfolios. Those assets tend to outperform during economic recoveries, and they have lagged in the 2020 rally of risk assets, so their valuations may be attractive. Our third investment idea is to identify and use skilled active management. The shift from the pre‑pandemic, relative benign environment, through the shock of the crisis, to the post‑pandemic recovery has caused considerable volatility and divergence between prices and intrinsic values. This environment is ripe for active management to add value, especially as some asset valuations are stretched, making it harder for passive investing to generate attractive returns.

2. Politics and the pandemic In normal times, geopolitics are mostly background noise for markets. However, such ‘normal’ times have not existed for more than a decade. The pandemic has accelerated a series of secular changes, including the widening wealth gap, rising social discontent, growing populism,

increased protectionism, and the rise of China. Although we expect President Biden to be less confrontational than President Trump, and the terms of the United Kingdom’s exit from the European Union to be substantively resolved, we believe geopolitical tensions are here to stay. Geopolitical disorder and change impact every region of the world. The United States must adapt to a new president and new administration’s policies while facing the possibility that a divided Congress will lead to regulatory gridlock. The ‘Japanification’ of Europe is underway, putting strain on the EU and its unity. In Russia, the leadership may change. China is emerging economically stronger from the pandemic, lifting tensions with the US in what we call Cold War II. Our first investment idea here is to focus on assets in domestic markets with lower sensitivity to global turmoil, currency swings, and changes to globalised business mod-

Investment idea 2. Politics and the pandemic Investment idea

Domestic markets

Global investing

China and emerging Asia

Rationale

Trade tensions, currency manipulations, and rising protectionism are reasons to focus on investments less sensitive to global turbulence, less export oriented, and more geared toward strong domestic markets.

Instead of betting on the fortunes of a single local currency, invest globally to benefit from a wide investment opportunity set, flexibility, and diversification.

While its reputation might be dented, China can emerge in pole position economically. Other Asian economies, such as Taiwan and South Korea, have also recovered strongly.

Examples

• Small-caps • US equity • US bank loans.

• Reduce home bias • Global stock selection • Currency-hedged global fixed income.

• Chinese equity • Asia ex Japan equity • Asia credit.

Source: T. Rowe Price

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els and supply chains. Another idea is to diversify and invest globally, searching for opportunities wherever they are in equity and fixed income markets, thereby reducing the risk of a major geopolitical development adversely affecting the domestic market. Our third idea in this theme is to invest in China and emerging Asia. This group of countries compose about 80% of the MSCI Emerging Markets Index and may emerge as winners as they have been less impacted by the pandemic. Luckily, China needs to export its produce to the US and find a home for its domestic savings, while the US needs to import goods from China and finance its trade and government deficits, keeping a balance between the two superpowers.

3. Policy and low yields The pandemic and geopolitical tensions have driven policymakers to stimulate the regions under their responsibility. If unconventional monetary policy and the expansion of central banks’ balance sheets became the new normal over the past decade, fiscal stimulus and expansion of public deficits will become the new-new normal of the next decade. In nearly all developed economies, firms and consumers will continue to benefit from record‑low interest rates. Quantitative easing will continue if it is needed, leaving governments with no choice but to borrow and spend. Adam Smith’s invisible hand has disappeared. The economic slowdown, combined with ultra‑accommodative policies, is likely to keep downward pressure on bond yields. Yields may rise from their 2020 historic lows, but material increases are unlikely. One reason for this is the likelihood of continued weak economic growth and inflation. Inflation might rise, but not significantly in the next 12 months before the economic recovery is on a strong footing. Another reason is persistent asset purchase programmes by central banks – ‘fighting the Fed’ has proved to be a loser’s game over the past decade or more. A third reason why yields are likely to remain low is that when bond yields rise, investors such as pension funds rush to buy government bonds at slightly better prices, putting renewed downward pressure on yields. For all these reasons, yields and income are likely to remain scarce in 2021. In this environment, one investment idea is to invest in risk assets, despite the discomfort of uncertainty and rich valuations. Risk assets should continue to receive support from central banks, which are likely to support markets if data deteriorate. A second idea is for income‑seekers to expand their opportunity set in the search for yield. Some assets, such as high yield, enjoy explicit support from central banks. Others, such as emerging market debt, may benefit from recent US dollar weakness, which we expect to be a continued trend in the medium term. Although default rates could rise due to the pandemic, policies should support some firms,

effectively bailing them out, keeping default rates at bay and spreads narrower than where they would be without policy intervention. Skilled active management and credit research can help to mitigate exposure to defaulting issuers. Our third idea here is to seek assets that may benefit from fiscal spending and potential new policies of US President Biden.

Investment idea 3. Policy and low yields Investment idea

Risk assets

Yielding assets

Fiscal policies

Rationale

Easy policy may inflate the prices of financial assets as it did in the aftermath of the 2008 global financial crisis.

High-yielding assets may be in demand from income-seekers and benefit from central banks’ support and, in some cases, from expected US dollar weakness.

Governments must spend. The Biden administration may support an infrastructure boom, anchored by green energy. Environmental, social and governance (ESG) factors may enjoy continued support.

Examples

• Global equity • Global high yield.

• Global high yield • Emerging market sovereign debt local currency • Emerging market corporate debt.

• Infrastructure • Green energy • ESG strategies.

Source: T. Rowe Price

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4. Parting styles amid disruption Another key theme for 2020 was the diverging fortunes of different segments of the economy and markets. Volatility and the dispersion between losers and winners can create both risks and opportunities – while some areas keep suffering, such as hospitality and bricks‑and‑mortar retail, others may keep benefitting, such as technology and e‑commerce. The investment environment ahead is likely to be characterised by switching leaders and laggards. Rising infections and continued curbs on activity may cause a ‘risk‑off, COVID‑on’ environment with outperformance of growth, large‑caps and US dollar strength. News about vaccines and the easing of lockdowns may introduce a ‘risk‑on, COVID‑off’ environment, where value and small‑caps take the lead and the dollar lags. Our first investment idea here is to maintain a balance in portfolios between potential winners and losers while using active management to lean into cycles of outperformance. While the pandemic is destructive, destruction is constructive in some cases. As we adapt to life with the virus, some areas will flourish and disrupt, while others will wither and be disrupted. Our second investment idea in this theme is to select investments offering durable growth, despite the pandemic. Finally, the pandemic has led to diverging asset valuations. The price of some, such as technology and government bonds, rallied and their valuations now look like a headwind. The prices of others, such as financial and European equities, have lagged and their valuations now appear to be a tailwind. Although cheap valuations are not enough, a steadier economic recovery or a vaccine/cure, potentially leading to a market melt-up, may see some rotation to the laggards. Our third investment idea is to balance likely winners and neglected losers.

5. Pricey safety Ultra‑accommodative policy and pressured yields have pushed the prices of traditional conservative assets upward. The traditional way Investment idea 4. Parting styles amid disruption Investment idea

Balance

Durable growth

Neglected assets

Rationale

Instead of guessing which style is likely to lead and which one will lag, investors should balance styles in portfolios and use tactical views to tilt portfolios to styles they think are likely to outperform.

Some investments offer potential growth amid the economic slowdown due to the pandemic.

An economic turnaround or a vaccine/cure may be a catalyst for investments that have been left behind to catch up with the leaders. Balance is the key.

Examples

• Balance growth and value • Balance large- and small-caps.

• Technology and e-commerce • Healthcare • US large-cap growth.

• Financials sector • European equities • US large-cap value.

Source: T. Rowe Price Investment idea 5. Price safety Investment idea

Safe-haven currencies

Global bonds

Active defence

Rationale

Some currencies tend to perform well when risk assets fall because of a flight to quality.

Duration risk has diminished firepower to diversify equity risk. However, duration risk and high-quality bonds can still partially cushion weakness of risk assets. Anchored policy rates, subdued inflation, and anaemic economic growth may keep government bond yields at low levels.

Investors should consider diversified, actively managed defensive strategies that fit the future, not rely on duration.

Examples

• US dollar • Japanese yen • Swiss franc.

• Currency-hedged global aggregate or government bond • Unhedged US Treasuries • Defensive bond strategies.

• Defensive diversified strategies • Tail-risk mitigation derivative overlays • Managed volatility overlay.

Source: T. Rowe Price

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to diversify equity risk has been duration risk, but government bonds are currently expensive, with yields close to all‑time‑low levels. When yields are low, their scope to fall during sell‑offs of risk assets is reduced, limiting government bonds’ defensive power. The US dollar, another proven way to mitigate downside risk, is not cheap. Safety has become pricey. Because of uncertainty due to the pandemic and geopolitical tensions, safety is likely to remain expensive. One investment idea here is to include safe‑haven currencies in portfolios, expanding from the US dollar to include the Japanese yen and Swiss franc. A second idea is to use active strategies to tap into the global bond market and use other ways to mitigate downside

Investment

risk. Our third idea is to use every weapon in our arsenal to create an active, diversified defensive strategy, using both traditional and innovative techniques, such as derivative strategies with defensive characteristics. One key theme for 2021 is balance. Few investors can afford to retreat to less-risky assets, especially when many of these are looking expensive relative to history. Portfolios should balance investments that can tap the upside if markets continue to do well and investments that can mitigate downside risk if markets retreat. When the future is murky, portfolios should be prepared for either good or bad outcomes. fs

CPD Questions Earn CPD hours by completing this quiz via FS Aspire CPD. 1. The authors found that against the backdrop of COVID-19, investor behaviour has been: a) Continually subdued b) Mildly cautious c) Subject to bursts of optimism and pessimism d) Subject to bursts of rationally positive and cavalier behaviour

4. W hat do the authors see as an effective investment style for these times? a) Balance potential winners and losers in portfolios b) Overweight portfolios with value stocks c) Remove laggards from portfolios d) Choose investments offering short-term growth

2. A ccording to the authors, which of the following geopolitical occurrences have come to the fore during COVID-19? a) Social discontent b) Populism c) Protectionism d) All of the above

5. What do the authors recommend to avoid downside risk? a) Avoid the global bond market b) Expand into safe-haven currencies c) Retreat to less risky assets d) Exclude innovative techniques

3. The authors believe that fiscal stimulus and public deficits will contract sharply over the next 10 years. a) True b) False

6. According to the authors, active management is well suited to a post-COVID-19 environment. a) True b) False

Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

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CPD Earn CPD hours by completing the assessment quiz for this article via FS Aspire CPD. Worth a read because: Esports are a disruptive innovation impacting traditional spectator sports, which combined with the continued ascendency of video gaming, make a strong investment case. However, despite these compelling trends and fundamentals, most investors remain underexposed to this sector. Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

Investing in esports and video games The disruptive impact and potential for continued growth

T VanEck

he rise of video games and esports since the second half of last century has been gathering pace. Video games have evolved. They are now on our phones. We can play anywhere and anytime. Esports, a part of the video gaming industry, too has grown with events being broadcast to audiences that rival the global numbers watching the soccer World Cup. Esports has been identified as a disruptive innovation with the potential to significantly impact traditional spectator sports. For investors, an understanding of the dynamics that will likely continue to drive growth within the video gaming industry and esports can help them position their portfolios so they can capture the performance of an industry that has the potential to continue to go to the next level for several years to come.

The state of play Esports, a part of the video gaming industry, is currently a hot topic among investors. Mind-boggling statistics fill magazine and online articles. (Sites such as Newzoo, The Esports Observer and esports insider disseminate statistics and report on industry growth and cor-

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porate activity.) These impressive numbers are supported by commercial research too. In its The rise of esports investments. A deep dive with Deloitte Corporate Finance LLC and The Esports observer, April 2019 report, Deloitte found that the esports industry attracted over US$7 billion in investment over 2017, 2018 and 2019. There is no doubt growth in esports continues globally and it has spread to Australian shores. In May 2018, Qudos Bank Arena in Sydney, the largest indoor arena in Australia, was a sell-out for the Intel Extreme Masters. Our universities too are supporting esports. In August 2020 Monash University added esports to its Elite Student Performer Scheme, to support the next generation of gamers to compete on the world stage. The University of Adelaide’s Sia Furler Institute held a summit in 2020 with the aim to teach keen gamers how to turn a passion for video games into a professional career. Murdoch University secured funding to help build an esports stadium in Perth that will be linked with Singapore and East Asia. Elsewhere, Queensland University of Technology, RMIT (Royal Melbourne Institute of Technology) and the University of Melbourne, among others, all offer subjects examining esports. As an investment theme too, esports is now entering the mainstream. In an Australian first, VanEck launched its Video Gaming and eSports ETF (ASX code: ESPO) in September 2020.

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Video gaming and esports recent rise to prominence has been augmented by the COVID-19 lockdowns. Australian leagues such as the NRL and AFL were forced to cancel part of their seasons. Avid sports fans, self-isolating and craving their usual sports fix, turned to watching and playing video games. But the trends for professional sports leagues were not confined to COVID-19. Falling viewership and declining match spectatorship have been trends for some time. In the pages of Harvard Business Review, esports had been identified as a disruptive technology that is changing the sports viewing market. Using the framework (that now deceased Harvard professor and proponent of the “disruptive innovation” concept) Clayton Christensen outlined in that same publication many years earlier, this paper highlights the rise of esports, underscoring the penetration and strides the industry has already made as well as pinpointing opportunities for continued growth. At the same time, video gaming continues to grow as technology allows for new revenue streams. This paper further explores this growth trajectory of video gaming and esports, its revenue streams and business models, and the three interconnected potential growth accelerants shaping its future. Video gaming and esports should be considered by investors as a potential opportunity. The sector is also a diversification opportunity away from the FAANG giants: Facebook, Amazon, Apple, Netflix and Google owner, Alphabet which dominate many portfolios.

Advances in network technology allowed users to play together on their PCs using a local area network (LAN). Suddenly, competitors did not need to be using the same machines. 1990s

In the 1990s, Microsoft started to bundle video games into its Windows package Sonic the Hedgehog helped drive sales of the new Sega Mega Drive, and all the while, gaming tournaments would continue to spring up here and there. By now they were based on the fighting games of the time such as Street Fighter and Mortal Kombat, both of which had emerged in the early 1990s. Sony with its PlayStation entered the home video game market, at the same times PC games continued to encourage team and interactive play. Sony’s EverQuest led hundreds of thousands of users to join guilds, fight monsters, and level up in the multiplayer online world of Norrath.

History of video gaming and esports 1970s

The birth of home video gaming Some of the earliest video games were competitive. Pong, one of the earliest video games was released in 1972, and it involved two players hitting a pixelated ball back and forth. Atari released a home version of Pong in 1975. This was followed by the release of Atari’s Video Computer System in 1977. This featured gearsticks, interchangeable cartridges, and options for difficulty levels. All of a sudden, computer games were in people’s homes. It was also during the 1970s that arcade games moved beyond the flippers in pinball machines to buttons, joysticks and steering wheels. Taito’s Space Invaders was released in 1978. Its launch caused a shortage of 100-yen coins, and within a year over 60,000 Space Invaders machines were installed in American arcades. Researchers trace the roots of the esports industry to informal Space Invaders competitions held at video arcades in the 1970s.1 In 1980 Atari organised an official Space Invaders tournament. It attracted over 10,000 entrants. 1980s

Hand-held games became popular at the start of the 1980s In 1981, Donkey Kong threw barrels at Jumpman – Jumpman would evolve into his better-known moniker, Mario. It was not uncommon during this time that tournaments would be held as people tried to break record high scores. [American video gamer] Billy Mitchell’s 874,300 Donkey Kong score was a world record for 18 years. The year 1985 ushered in the release of Nintendo’s Entertainment System. This revived the home console industry which at the time had stagnated in the face of hand-held games. Nintendo followed its Entertainment System with Game Boy in 1989.

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2000s

It was in the early 2000s that esports, as a spectator sport, first took off The Sims, released in 2000, became the bestselling computer game at the time and the most popular game with female players. It was in the early 2000s that esports, as a spectator sport first took off in South Korea. Cable networks broadcast StarCraft tournaments. By 2004, over 100,000 fans were drawn to a stadium event.2 In 2006, Nintendo’s launch of its Wii console appealed to millions of people who had never before liked video games. Innovative, motion-sensing remotes got players off the couch and interacting with characters and events on screen. Doctors were known to recommend it to patients to encourage movement. Internet and mobile technological advances led to the next boom in video gaming. Mobile phones became hand-held gaming devices. Video games like Angry Birds, Words With Friends and Candy Crush made some people ‘gamers’ for the first time. The introduction of online services such as Xbox Live allowed console gamers to play cooperatively or against one another in games like first-person shooter Halo 2, paving the way for other popular online titles including Call of Duty.

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ADSL was superseded by high-speed broadband internet allowing more video content and new online services which, in turn, allowed more gamers to play each other online and stay more connected than ever before.

From 2010 onwards, things got bigger Multiplayer online battle arena (MOBA) games, which pit two teams against each other while blending strategy and role-playing elements together, became a hit. One of the most popular MOBA games is League of Legends. Over 13,000 people packed out Los Angeles’ Staples Center in 2013 to watch the world championship final of League of Legends. By 2015, one year after being acquired by Amazon, online video streaming service Twitch fuelled the growth of esports further. On this platform, 36 million viewers watched the League of Legends World Championship that year. In 2016, millions of people hunted for virtual creatures like Pikachu and Horsea in the real world with Niantic’s free-to-play hit Pokémon Go. In 2019, millions of people tuned in to watch a virtual asteroid destroy the map of Epic Games’ online battle royale game Fortnite. The game, which is free to play, had earned a staggering US$2.4 billion in 2018. Fortnite respawned two days later with a new map, Fortnite: Chapter 2. The 2019 Fortnite World Cup was one of the biggest esports tournaments ever. The 23,000-plus seats at Arthur Ashe Stadium in Queens New York, which has a higher capacity than Madison Square Garden in Manhattan was sold out through the weekend for the Fortnite World Cup. Forty-million players had participated in qualifiers hoping to make the Fortnite World Cup final which was also viewed by over 2.3 million people across YouTube and Twitch. The winner, Kyle ‘Bugha’ Giersdorf, a 16-year-old from Pennsylvania took home US$3 million in prizemoney. By comparison, when Tiger Woods memorably won the US Masters that same year, he took home US$2 million. Today

Today, esports and video gaming are bigger than ever Video games have become a part of everyday life. According to DFC Intelligence’s Global Video Game Consumer Segmentation report data of August 2020, there are now more than 3 billion gamers worldwide. More and more people are watching esports. Within esports, there are many teams, events, and organisers, with impressive prize pools, strong online communities, and streaming platforms such as Twitch, which allow users to view esports matches and watch their favourite gamers play live over the internet.

Esports as a disruptive innovation Harvard Business School identified esports as an example of disruptive technology that is changing the market.3 As mentioned, the theory of disruptive innovation was first promoted by Harvard professor Clayton Christensen. Christensen was catapulted to superstar status in tech savvy Silicon Valley in the 1990s. Applying Christensen’s framework to the trajectory of esports highlights the potential for these new markets. According to Christensen, disruptive innovation should either, “originate in a low-end market and move upstream to higher value

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markets” or create a “new market foothold”, meaning it creates a new market where none existed.4 Reviewing the history of video gaming and esports, it is littered with examples of these. Consider the first informal competitions held at arcades. There was no formal seating, people were crammed in and it was hard to get a good view. Yet, these events were well attended. Moreover, they have grown today to be held in purpose-built stadiums – the very trajectory of a disruptive innovation. As mentioned, “In the case of new market footholds, disrupters create a market where none existed”.5 One could argue Nintendo Wii created a market for older people to utilise video game technology to exercise. Noone expected games on phones when video games first came about, yet it is now expected to pass annual revenues of US$100 billion in 2023.6 Advances in communications technologies have created new markets for esports creating new market footholds, such as the growth of MOBA and associated events. Harvard’s Christensen further stated: “Disruptive innovations don’t catch on with mainstream customers until quality catches up to their standards.”7 Thinking about the history of video gaming and esports earlier, its growth has come about as telecommunications and wireless technology has improved. Smartphone-based gameplay has been improved by 4G and 5G technology. As the technology has improved, so too has adoption. This is a characteristic of disruptive innovation. When Apple launched its iPhone 12, a key promotional element of the launch event focused on MOBA games and how 5G and chip technology now made gaming seamless. It is important to remember that disruption is a process. The first video game companies and arcades struggled for many years to get their business models right. They found it hard, once they had made the sale, to continue to generate income from their customers. Mobile and internet technology now allows for in-game purchases. Advertising has become a major revenue stream. Esports teams are sponsored. There are media rights now, and tickets are sold to a growing audience. The process of disruption has taken decades. The rise of esports, as a spectator sport, has taken decades. Companies such as Amazon are playing straight out of the Christensen

playbook, and buying into its potential. Amazon purchased Twitch in 2014, and its average monthly viewership is now on par with several cable news networks. The rise of Twitch, a platform that allows users to livestream gameplay and engage with other players online, unlike the linear format of traditional sports broadcasting, creates a more engaging viewer experience. Professional sports further embraced the disruptive innovation during the COVID-19 lockdown. Formula 1’s F1 Esports Series is one such example. The series achieved 30 million views during the 2020 lockdown period of March to June. The series was created to allow fans to have a Formula 1 race weekend experience in the absence of real races. F1 drivers and other sportspeople and celebrities duked it out virtually on accurate depictions of real-life racetracks. Video gaming and esports have created new markets over a period of many decades. The growth over the past few years is likely to continue as technology continues to improve the experience for users. Professional spectator sports too have responded to the disruption. Slowly at first. ‘Madden’ has become its own brand under the US National Football League (NFL). Despite launching in 1988, Madden only received its official NFL licences in 1994. Other professional leagues have similar licensing, but the US National Basketball Association (NBA) has been a first mover responding to the disruption as it has moved upmarket. In 2018, the NBA partnered with TakeTwo Interactive to form the NBA 2K League, the first official esports league operated by a US professional sports organisation. Disruptive innovation explained

In his book The Innovator’s Dilemma, Clayton Christensen’s introduced the world to three types of innovation: 1. Revolutionary: These are very rare. They result in products that are so improved or new that they simply replace the previous product (e.g. the horse and buggy was replaced by the car). 2. Sustainable: These are common. They are incremental improvements on existing products (for example, the fifth blade in a razor, the clearer TV picture, better mobile phone reception or lower costs).

Figure 1. The disruptive innovation model

Source: VanEck

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Figure 2. Global games revenues

Source: Newzoo, 2020 Global Games Market Report, *Projected

Figure 3. Revenue comes from a variety of sources

Source: Newzoo, 2020 Global Games Market Report, numbers are projected.

Figure 4. Esports revenue growth

Source: Source: Newzoo. Global Esports Market Report 2017, 2018, 2019, 2020. Past performance is not indicative of future results; current data may differ from data quoted. *Projected.

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3. Disruptive: These are also rare. They create new markets. According to Christensen, disruption is a process whereby a company is able to successfully challenge established incumbent businesses. Specifically, as incumbents focus on improving their products and services for their most demanding (and usually most profitable) customers, entrants that prove disruptive begin by successfully targeting overlooked segments by gaining a foothold through delivering more-suitable functionality, frequently at a lower price. Incumbents, chasing higher profitability in moredemanding segments, tend not to respond vigorously initially. Entrants then move upmarket, delivering the performance that incumbents’ mainstream customers require, while preserving the advantages that drove their early success. When mainstream customers start adopting the entrants’ offerings in volume, disruption has occurred.

Technology: Harder, faster, better, stronger Technology is one of the three factors driving growth in video gaming and esports. There are two other key accelerants shaping its future These are new markets, such as emerging markets, and the generational trends. Further, they are all interconnected. The growth of video gaming and esports has been facilitated by improvements in technology. Technology will continue to evolve, and this will drive the growth of video gaming and esports further. We are fast approaching being able to develop graphics that simulate the real world. Graphics have already been ‘virtually’ added to our world (for instance, Pokémon Go). Virtual reality will create experiences that can only be achieved digitally. We will be able to go to new, realistic worlds and have experiences that at the moment are the realm of science fiction. Technology also creates cost efficiencies because once games and worlds are created, they can be used over and over again. So far, technology has driven growth in esports and video games by improving accessibility. First, games consoles were able to be in people’s homes more, and this breakthrough led to more people becoming ‘gamers’. Then the first LANs and now high-speed internet and 5G allow us to compete, share and watch games with more and more people. The ability to play many people at any time from any location for which a phone can receive a signal has propelled video gaming and esports. However, there are other improvements in technology that will further improve the access. We expect other entertainment forms to respond to improvements in technology the way professional sports such as F1 and the NBA have. Technology will allow for the merging of entertainment experiences. Movies and television, rather than just being a one-way engagement (a TV program streams at you), will adapt to become a two-way

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engagement. Then, crowd engagement, watching with a group of people. It is not out of the realm of possibility that watching the watchers of these technologies will become popular. The groundbreaking TV series Black Mirror episode ‘Bandersnatch’ utilised this technology. Improvements in accessibility open up new markets, and as technology gets better, efficiencies improve and devices become cheaper. Emerging markets are an example of this. Unlike in developed markets, the boom in video gaming and esports has the potential to be much faster in emerging markets. This is due to improvements in technology. China is a good example of the growth potential there is in other emerging markets where video game use is currently low. China is now a ‘developed’ market in esports and video gaming, however, that has not always been the case. China’s has had the fastest-growing economy over the past 20 years. It is among many Asian countries (particularly Singapore, Indonesia, India and Korea) that have experienced exponential growth in digital knowledge, production and consumption.8 China has evolved to become one of the world’s largest investors and adopters of digital technologies. It is home to one-third of the world’s unicorns. McKinsey’s China’s Digital Economy: A Leading Global Force 2017 discussion paper noted that unicorns are defined as privately held startups valued at over $1 billion. Digital heavyweights in China such as Tencent, NetEase and Bilibili are notable players in the video gaming and esports industry. Unlike the Western-world situation outlined earlier that most of us experienced, gamers in China had a different journey. It did not start in arcades in the 1970s. Mario was the first character Chinese gamers could access.9 South Korea’s StarCraft built up a following in China, but once the internet was introduced to China in 2009, it started to replicate the Korean experience.10 And soon took over. The advent of the mobile phone saw exponential growth. Many of China’s population were, for the first time experiencing video gaming. China is now the most active esports country in the world, with more events and tournaments than any other country. The rise of China as an epicentre in esports has coincided with its improvements in technology.11

Advancements in technology improves accessibility in emerging markets, and this will continue beyond China. However, like China, the growth in emerging markets will be more rapid than what developed markets experienced. Gamers in emerging markets will not reminisce about the Atari 2600 or Commodore 64. Their adoption patterns will be more like those of Generation Z – possibly the first generation of lifelong gamers. They often experience their first game on a smartphone, perhaps watch people playing video games on YouTube, and thus video gaming and esports become intertwined with their life. That is not to disregard the potential of other markets. For instance, Generation X and Millennials in developed markets have grown into adults and they continue to spend time and money on playing video games. According to the Entertainment Software Association, 65% of American adults play video games.

Tapping into growth The video game industry is tapping into global consumer demand for online, interactive entertainment, leading to record-setting revenues and an unprecedented user base. Newzoo’s 2020 Global Esports Market Report forecast that the total video game industry was projected to reach US$174.9 billion in revenues, which according to 2019 Bloomberg Intelligence data, makes it a bigger industry than both cybersecurity and robotics. Further, Newzoo’s 2020 Global Esports Market Report forecast that by 2023, video gaming could reach US$218 billion (Figure 2), representing a 9.4% compound annual growth rate between 2018 and 2023. The video game industry is enjoying a long-term structural growth, supported by broader trends, including demographic shifts and cord-cutting. Esports, as a part of the video gaming industry, is experiencing rapid growth too. Its revenue has tripled over the past three years. Esports is growing across audiences, participants, sponsorships, advertising, and team franchises. As a result, revenue is coming from a variety of sources. Another indicator of the potential growth of esports is observed through the total revenue per fan, which shows how well a sport is ‘monetized’. Since 2014, the global average revenue per person of esports enthusiasts has increased by about 175% (Figure 4).

Figure 5. 2020 Global esports market forecast revenues per stream

Source: Newzoo, 2020 Global Esports Market Report, April 2020 update.

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CPD Questions Earn CPD hours by completing this quiz via FS Aspire CPD 1. To what event have researchers traced the origins of the esports industry? a) The initial release of video games such as Pong, in 1972 b) The rising popularity of hand-held games in the 1980s, such as Donkey Kong c) The first release of the life simulation video game, The Sims in 2000 d) Informal Space Invaders competitions held in video arcades during the 1970s

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We are witnessing a cultural paradigm shift as esports athletes and competitions are considered by many to be on par with traditional sporting event participants. The International Olympics Committee even announced in the sixth session of its summit in October 201711 that esports should be recognised as a sporting activity. Elsewhere, we are witnessing major investments by video game developers, large technology companies, professional sports teams, cities, municipalities and advertisers attracted to audience bases that are young, have money, and appear to be willing to spend over the long term. Despite these compelling trends and fundamentals, most investors are underexposed to this sector. Esports and video games comprise only 4.82% of the NASDAQ 100 and only 3.71% of MSCI’s information technology sector (Figure 6). fs Figure 6. Exposure to video gaming and esports as at 30 November 2020

2. Esports is termed a disruptive innovation according to Clayton Christensen’s explanation of three of types of innovation because: a) They have created a new market that challenges existing sporting businesses b) They represent an incremental advance upon pre-existing gaming options c) They have almost replaced participation in live physical sports d) They rely on advertising and sponsorship for their survival 3. Which country presently holds the most esports events and tournaments? a) China b) United States of America c) India d) Indonesia 4. What three factors are the primary drivers of growth in video games and esports, as identified by the article? a) MOBA games, generational trends and emerging markets b) Crowd engagement, advertising and technology c) New markets, technology and generational trends d) Esports team sponsorship, newly-created markets and MOBA games 5. The International Olympics Committee announced in 2017 that esports should be recognised as a sporting activity. a) True b) False 6. Video gaming and esports represent 10% of both the NASDAQ 100 and MSCI’s information technology sector. a) True b) False Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

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Source: FactSet, as at 30 September 2020. Weightings represent weighting in respective comparable indices.

Notes

1. Bose R, Mercer Capital Whitepaper series: Esports, 2020. 2. Bose R, Mercer Capital Whitepaper series: eSports, 2019. 3. Gavin M, ‘3 Examples of Disruptive Technology That Are Changing The Market’, Harvard Business School Online, blog, October 2018. 4. Christensen CM, Raynor ME, and McDonald R, ‘What is disruptive innovation’, Harvard Business Review, December 2015. 5. ibid. 6. Statistca – ‘Mobile gaming – statistics & facts’, n.d. 7. Christensen CM, Raynor ME, and McDonald R, ‘What is disruptive innovation’, Harvard Business Review, December 2015. 8. Yu H, ‘Game on: the rise of the esports Middle Kingdom’, vol. 5, issue 1, 2018, RMIT. 9. Yue Y 2018, ‘Research on esports and esports Industry in China’, China Institute of Sport, 2018. 10. ibid. 11. Yu H, ‘Game on: the rise of the esports Middle Kingdom’, vol. 5, issue 1, 2018, RMIT.

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CPD Earn CPD hours by completing the assessment quiz for this article via FS Aspire CPD. Worth a read because: The current imbalance between supply and demand for social housing in Australia is an undeniable issue. This paper examines some of the solutions for attracting new investors into social housing and potential challenges. Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

Addressing housing affordability in Australia

Matthew Tominc

f there is one positive to take away from the past year, it is the importance of what we do together. The year 2020 revealed that the adverse impacts of a pandemic fall disproportionately on the most vulnerable. That is, people living in poverty, the working poor, women and children, persons with disabilities, and other marginalised groups around the world. Loneliness and mental health issues spiked among our most vulnerable, millions of children experienced a new mode of education and, of course, we were reminded that like a pandemic, climate change can have far-reaching consequences for our global economy if left unchecked. Social housing is the focus of this paper, in which we look at the sector and how to address the challenges of social housing investment in Australia.

Why is housing such a challenge? Few would dispute that housing is a fundamental human need. Yet even in a developed economy like Australia, the provision of stable housing is not guaranteed. Housing is also an asset class and sits at the intersection of human needs and financial markets. Hence, it is an area where impact investment is uniquely suited to address the challenges society faces in providing shelter to those in need. Housing affordability is a challenge globally, and is particularly

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acute in Australia, where demand- and supply-side factors have combined to increasingly push housing beyond the reach of many families. In the short term, house prices increase because of demand-side factors – government policies encouraging home ownership designed to create financial security for voters, falling interest rates, and wealth inequality that drives demand for certain types of housing. Over the longer term, house prices stay high because of supply side factors, including: • Lack of appropriate supply to address demand. • ‘Not in my back yard’, or NIMBYism, stalling development of new housing stock at scale. • In some cases, policies designed to support housing (such as rent controls) that also deter new developments.

How big is the challenge? Based on Australian Bureau of Statistics’ 2016 Census data, on a given night in Australia, 4.2% of households need to rent social housing. Yet that statistic only captures families able to access existing social housing. It does not account for the large wait lists of people vying for shelter. Delving into the state level provides a better understanding of some of the challenges, as all states in Australia are governed by different regimes and dynamics for social housing. The Housing Peaks Alliance’s (HPA) Make social housing work: a framework for Victoria's public and community housing 2020–2030 re-

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port made the following findings. Victoria has the lowest level of public and community housing stock in Australia (3.2% of all housing stock). The national average sits at 4.5% of all housing stock as social housing. To simply maintain its social housing stock at 3.2%, Victoria will require 3,500 new social housing beds to be built every year for the next 10 years. Similar calculations can be made for other states. According to New South Wales Department of Communities and Justice figures for 30 June 2020, there were around 51,390 applicants on the social housing wait list. Of these applicants, close to half were households with children. Wait times were beyond 10 years for social housing in many areas.

What are some solutions? Matthew Tominc, Conscious Investment Management Tominc is Conscious Investment Management’s founder and chief investment officer, responsible for identifying and executing new investment and divestment opportunities. Previously, he was head of investments at Light Warrior Group, one of Melbourne’s largest family offices. Matthew has 12 years’ experience across portfolio management, impact investing, deal sourcing and structuring, mergers and acquisitions, capital markets and law. He holds a Bachelor of Laws (Honours)/ Bachelor of Commerce (Finance).

Governments and various community organisations have tried different policies and approaches over the past few decades, with varying degrees of success. Incentives and concessions for developers, planning restrictions, direct financial support of community housing charities (for instance, through cheap debt), or cash payments directly to social housing tenants all have a role to play. A major boon for the sector was the launch

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of the Commonwealth’s National Housing Finance and Investment Corporation (NHFIC) in 2018 to provide an increase in low-cost financing for social and affordable housing providers. Financial markets and institutional investors have also begun focusing on the sector over recent years, attracted by perceived scalability and stability of returns. A challenge for these investors, however, is that investors typically require ‘market’ rate financial returns. By definition, social housing tenants cannot pay market rent. That disconnect is difficult to solve and remains a key reason why financial investors have not entered the asset class at scale. As an illustration, to address many of these challenges, Conscious Investment Management has focused on the sector from a few angles as outlined in the following discussion. Considering build-to-rent investments

After a positive experience investing in the United States’ ‘multifamily’, or ‘build-to-rent’ sector, which has been responsible for significantly increasing affordable housing supply in the US, we have sought analogous investment opportunities in Australia.

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Build-to-rent in Australia is a new industry, and many build-torent developments underway are not necessarily ‘affordable’ (even if marketed as such). We expect to continue assessing the sector.

ment in a sector as it matures towards institutional-scale investment. This is the most attractive way to structure social housing investments, but also the most challenging.

Working with community housing providers

Conclusion

Working with community housing providers, often charities, provides insights and fresh ideas as to how funding can play a role to support their mission. For example, we have explored pairing social housing with specialist disability accommodation or other commercial real estate to obtain a ‘blended’ market rate return.

Impact investors are dually focused on long-term investments that drive positive change, as well as the generation of stable and strong returns for investors. It can take months and even years to gain an understanding of an area of need and the sector that seeks to address it, so as to make investments that can combine both impact and financial returns. fs

Direct engagement with governments to seek a concession.

Analogous to investment in specialist disability accommodation, government support can assist in addressing the gap between what a tenant can afford and market returns. By plugging the gap between market returns and social housing rents, governments can drive increased private sector engagement and invest-

This information is provided by the Investment Manager, Conscious Investment Management Pty Ltd ACN 630 131 476 AR No. 1275316 (‘CIM’) is an Authorised Representative of MARQ Private Funds Pty Ltd AFSL No 473984 ACN 604 351 591. MARQ is the Trustee and issuer of units in The Impact Fund (‘the Fund’). Channel Capital Pty Ltd ACN 162 591 568 AR No. 1274413 (Channel) is CIM’s distribution partner. This information is supplied on the following conditions which are expressly accepted and agreed to by each interested party (‘Recipient’). This information does not purport to contain all of the information that may be required to evaluate CIM or the Fund and the Recipient should conduct their own independent review, investigations and analysis of CIM, the Fund and of the information contained or referred to in this document.

CPD Questions Earn CPD hours by completing this quiz via FS Aspire CPD. 1. How is housing primarily categorised for the purposes of this paper? a) As an asset class b) As a fundamental human need c) As a social need d) As a fundamental financial need

4. H ousing prices in Australia remain elevated over the longer term due to the impact of factors such as: a) Economic settings to facilitate low and falling interest rates b) Home ownership equating to personal financial security c) Wealth inequality driving demand for specific housing stock d) NIMBYism delaying new large-scale housing developments

2. One of the most successful incentives in recent years to promote the social housing sector has been: a) Encouraging the spread and uptake of build-to-rent developments b) Pairing social and specialised disability housing to improve investors returns c) Providing low-cost funding to providers of affordable social housing d) Directing cash payments to developers of social housing

5. Which of the following presents one of the greatest challenges in attracting investors into social housing? a) Government-imposed planning restrictions b) The absence of market rates of return c) Excessive volatility in historical returns from social housing d) Lack of sufficient tenant demand for social housing

3. Social housing makes up just 4.5% on average of all Australian housing stock. a) True b) False

6. The wait times for social housing in many areas exceeds 10 years. a) True b) False

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