Hewison Quarterly - Issue 43 - April 2013

HEWISON Financial news, our views AND other issues Issue 43 ~ April 2013

Q

uarterly • Is the worst behind us?

• From the CEO’s Desk • Income investing • Compounding...

• Reporting season update

• Recap on Don Stammer • Smart investor top 50 • Hewison Private Wealth investor insight series for 2013

Understanding the terms we use Bull Market A market whose level has risen for an extended period. Traditionally, a market which has risen by 20% can be described as a Bull Market.

Compounding (of income) Term for income generated by an asset (dividends for equities and coupons for bonds) which, when reinvested, generates its own return.

Government Bond A bond that is issued by a government.

Non-Government Bond A bond issued by a non-government issuer. Usually this is a company or a an organisation, like the World Bank. The price of the bond is influenced by the issuer’s financial health as well as the outlook for interest rates and inflation. Non-government bonds are normally seen as higher risk than government bonds because of the greater risk that issuer will default on their obligations to pay interest or repay the bond’s principal amount on maturity.

Strategic Asset Allocation SAA or Strategic Asset Allocation refers to the composition of an asset mix within a portfolio, constructed with the aim of meeting the long-term objectives of a fund, rather than being based on short-term views of relative performance of the various asset classes. Usually a benchmark is derived in this fashion.

Is the worst behind us?

Story by Simon Curtain DIRECTOR/PRIVATE CLIENT ADVISER

T

he last few months have certainly been good for investors and it is good to see those that held their nerve being rewarded with some strong gains on the share market At the time of writing, the Australian market is up around ten percent this year and the Dow Jones index in America has just hit an all-time high.

So what exactly has changed, and is the worst behind us?

Regular readers of our newsletters would have noticed a shift over the course of 2012 as markets around the world came to terms with the European Debt Crisis and whether or not Greece would remain in the Euro. While 12 months ago the mere mention of ‘Greece’ in a newspaper headline would send the market into a tail-spin we are now seeing a more controlled approach to the crisis. While it will take decades for the Eurozone to sort out its debt woes, it would seem that the market is confident the Europeans are on the right path and is content to let them muddle their way through.

In a similar vein, throughout 2012 markets were concerned that the Chinese economy would enter recession and derail global growth. While Chinese growth has certainly slowed it is far from the hard-landing many predicted with growth of around 7.5 per cent in the previous 12 months. With many Western nations struggling to record growth of 2 – 3 percent we hardly think that 7.5 per cent is a poor effort!

Image by Nicolas Raymond

In the US there was much hype and speculation that the Fiscal Cliff would plunge the US economy into recession on January 1st.

As expected, US politicians came to a last minute deal that staved off any serious changes and the situation in the US continues to improve with the Government committed to spurring the economy along with its quantitative easing strategy (printing money).

Closer to home, we have seen interest rates remain at their all-time low of 3 percent and unemployment steady at 5.4 percent. While some reports say that the mining boom is over, others show that investment in mining is set to continue for a few more years yet.

As you can see, a number of things have changed over the past few months, all helping to increase global growth and breed confidence and if there is one thing markets thrive on it is confidence.

While many are now predicting we are in the early stages of a bull market, we are cautious about getting too caught up in the hype and prefer to take a more sensible approach to investment. While we think that the worst is now behind us, we have long believed that regular rebalancing of portfolios back to their strategic asset allocations achieve client objectives in a variety of market conditions and we continue to monitor the economic landscape to identify any additional opportunities for our clients.

From the CEO’s Desk

Income investing Story by John Hewison, CEO

John Hewison

The Federal Government’s Future of Financial Advice (FoFA) reforms come into force from 1 July 2013. Central to these reforms, which have been widely debated, is the requirement for financial advisory firms to clearly disclose to their clients the full detail of costs they are being charged and what service is being provided in return.

Clearly, this is a massive problem for many financial advisers who have been receiving ongoing “service commissions” but providing no service. Many clients are about to discover the extent of costs that are being withdrawn from their investment of which they were not fully aware. We have seen examples where this has been as much as 2-3% per annum.

This all stems from an industry that somehow thinks it is entitled to gouge money from clients to fund convoluted multi-tiered businesses that frankly cannot justify their existence. As a result we have seen a raft of mergers and takeovers of advisory companies that have become painfully aware that the basis of their remuneration is flawed and will be outlawed by FoFA and more importantly, will not survive scrutiny by their clients.

We have aggressively campaigned against these multi-strata cost arrangements for over 20 years. At every level they are loaded with commissions and kick-backs based on product sales and volume incentives which are in no way related to client interest or service.

We have always argued that the only relationship that exists in the financial advisory process is that between advisor and client – everything else is a service provision that should be priced according to the value it We are steadfast in our belief that independence is the key to untainted advice and consumer trust. Sadly, FoFA will cause further polarisation of financial advice to majority ownership by large institutions with vested interests. This will deprive the consumer of a wide choice of independent advice options – certainly not the intended outcome.

Investment markets always move in ever repeating cycles and it is important to devise strategies to maintain the performance criteria required. Often, a key performance requirement is that of reliable income.

As depicted by the diagram below, asset classes perform differently during stages of the cycle.

Generally speaking, income investments are categorised as fixed and variable interest securities. But in reality, interest bearing investments are as volatile as any other asset sector as we are currently experiencing at the low end of the interest rate cycle.

An important factor of income investing is inflation, that is, keeping pace with annual increases in the Consumer Price Index (CPI) or the continually rising cost of living. As a general principle, investment strategy needs to include a growth component to ensure the capital and its income generation capacity increases at least at the rate of increases in the CPI. The fact is that different types of investment produce different outcomes – but often they are viewed differently, usually as a result of broadly held assumptions. For example, if it were suggested that shares and property were

Australian Company Shares We have recently seen share markets fall dramatically providing outstanding opportunities to buy quality assets cheaply with extremely attractive income streams. The following are some examples of blue chip investments that presented income opportunity for investors:

excellent income investments. Many would be surprised as they are generally seen as growth investments subject to high levels of volatility.

This whole issue of the assumed attractiveness of assets sectors should be placed into perspective to gain an insight into the issues surrounding good investment decision-making practices, particularly in respect to reliable income generation.

Whilst it is true that investments should be made for the long term, often referred to as “time in the market” it is not true to suggest that investments should be set and forget.

This is where an element of “timing the market” is essential to lock in profits and take advantage of opportunities as investment cycles change.

Fixed and variable interest rate investments There are a number of highly secure fixed rate investments such as Secured First Mortgages and term deposits. Variable interest rate investments will usually be in the form of ASX-listed hybrid investments which pay interest based on a margin over a reference rate such as the 90 day bank bill rate.

The important factor with managing interest bearing securities is to maintain a mix of investment types and maturity dates to help maintain a smoothing of returns throughout the investment cycles.

The power of shares as an income investment cannot be ignored. It should also be understood that shares generally increase their dividends annually and as a result effectively index income to offset inflation.

Share

Price at bottom Market 2009

Share price 3/4/2013

Income return today (on cost)

ANZ Bank

$12.36

$28.85

16.76% p.a

Commonwealth Bank

$24.07

$69.18

21.43% p.a.

Telstra

$2.75

$4.52

14.55% p.a.

Wesfarmers

$15.00

$40.78

16.38% p.a.

Property Whilst residential property provides a relatively low rental income return, commercial and industrial properties generally provide attractive returns with the tenant responsible for paying most of the outgoings. It is possible to invest in quality property investments producing income rates of between 6.5 – 8.5%, usually with

annual rental reviews to offset inflation and the opportunity for future capital growth Portfolio cash flow requires constant management and it is important to incorporate market timing in anticipation of expected future trends in the interest rate cycle.

Compounding…

Story by Andrew Hewison, Director/Private Client Adviser

The word itself implies a powerful meaning, if you ask me. Let me assure you, it is!

In financial terms, compounding refers to an asset’s ability to generate earnings, which is then added to the original sum and re-invested. The earning rate can be the same, but because the re-investment sum is growing, so too do the physical returns.

Case Study –

The investment is now worth $1,100,000. In year two, the share appreciates another 10%, so his investment value rises to $1,210,000.

Rather than Richard’s investment growing by $100,000 (10%) in year one, it grows $110,000 in year two, even though the growth in the company remained at 10%.

The table to the right depicts the long term effect in this example above –

Richard invests $1,000,000 in an airline.

The first year, the shares rise 10%.

Whether you have $1,000,000, or $1,000, the compounding nature remains the same. Younger people should take particular note as they can make best use of compounding over a longer period of time.

Fact – Westfield listed on the stock exchange in June 1960. A $2,000 investment back then into Westfield shares, allowing the dividends to be re-invested and without taxation impacts, would have been worth $320,000,000 in 2006 when Westfield peaked at $24.

Compounding in Super – The power of compounding in superannuation becomes even more powerful due to low tax rates. Younger people in particular dismiss super contributions on the basis that they cannot access the money. But take a look at the following comparison –

Year

Balance

2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

$1,000,000 $1,100,000 $1,210,000 $1,331,000 $1,464,100 $1,610,510 $1,771,561 $1,948,717 $2,143,589 $2,357,948

Scenario 1:

Result:

• Kate is 30 years of age and earns $100,000 per annum. She has $60,000 invested in superannuation.

• Kate has forgone income of $9,225, but increased her super balance by $123,000 over 25 years.

• I’ve factored in 9% super guarantee contributions (we will ignore the planned increase to 12% here), indexed at 3% per annum.

The key take outs are:

• Projected returns of 10% per annum.

- In addition to establishing an investment portfolio, as the super example suggests, by adding savings to your investment you are magnifying the compounding nature of your investment.

• Over 25 years Kate could accumulate $1,606,000.

Scenario 2: • Kate decides to salary sacrifice an extra $5,000 for three years only, from 2013-2014.

As result her take home salary reduces by $3,075 per annum.

• Over 25 years Kate increase her balance to $1,729,000.

- If you intend to become very wealthy, start investing earlier. The earlier you invest, the wealthier you’ll become.

- Resist the temptation to fiddle with your investment. Be patient. Compounding becomes more and more powerful as time goes on.

Reporting season update In what was expected to be a tough reporting season for Australian companies in February, it turned out to be quite positive.

According to data released by CommSec, around 85% of companies listed in the ASX 200 reported a profit. Further to this, 54% of companies that reported managed to increase

their profits compared to last year. Considering the challenging economic conditions many companies are facing, it was a promising sign to see that more than half the companies were able to increase their profits. Overall dividends increased across the board which is another positive sign.

A key theme that was recognised in this reporting season was cost cutting initiatives employed by companies. In challenging economic conditions, many companies are taking the conservative approach of cutting costs to boost their bottom line.

Recap on Don Stammer • Having lived through Australia’s last six recessions, Dr Stammer assures us of one thing – it is never “different this time”.

• Markets have always and will always move in cycles. This current upward trend has a way to go, but like all cycles, will not last forever.

• Whilst sharemarket dividends continue to return higher than Government Bonds, it will remain a good place to invest.

• Many long term investors preach the investment principal “time in the market,” opposed to “timing the market.” Don suggests that successful investment strategies require both.

The final point above directs us towards the importance of re-balancing your portfolio.

This is a task your Hewison Adviser manages for you on an ongoing basis.

Hewison Private Wealth was thrilled to welcome Dr Don Stammer to our annual Investor Forum at The Melbourne Arts Centre in February 2013.

Your portfolios are under constant review and if changes need to made, rest assured we will be in contact with you.

Thank you very much to those who could attend. The feedback received was overwhelmingly positive toward Dr Stammer’s presentation and the venue itself.

A copy of Don’s presentation is available via email. Please email clare@hewison.com.au to obtain a copy.

As a recap for those who attended and an insight for those who missed it, Dr Stammer’s key themes were:

A video copy of Don’s presentation is available on our website www.hewison.com.au/live

Smart investor top 50 Hewison Private Wealth Private Client Adviser, Chris Morcom was recently named in the Top 50 Honour Roll in the annual Financial Review Smart Investor Masterclass for Financial Planning 2013. This is an exam based test for CFP professional advisers.

The exam tests entrants on their knowledge of the relevant rules and regulations and how best to apply them to individual scenarios. It is based on the idea that the most value a financial planner can provide to individuals is through education and strategic advice, and operates on the premise that the best financial planners have an intimate and up-to-date understanding of the rules and regulations that govern our financial affairs.

Chris has previously been named in the top 50 Advisers for 2010 and 2011, and was named in the top 10 Advisers in 2012.

• We are on the market recovery upward cycle, definitely strengthening in both overseas and Australian equity markets.

Hewison Private Wealth investor insight series for 2013 In the first of our Hewison Private Wealth Investor Insight Series for 2013, Hewison Private Wealth Director Chris Morcom will provide attendees of this session with an

overview of issues SMSF trustees need to know about, and an update on key changes to SMSF regulations. We will run a number of these in-house seminars during the year.

Date

Topic

Speaker

Venue

Tuesday 30th April 2013

“Self Managed Super Fund Education Series”

Chris Morcom

@ Hewison Private Wealth 4/102 Albert Road SOUTH MELBOURNE

July 2013

“Young Wealth Forum”

Andrew Hewison and Simon Curtain

@ Hewison Private Wealth 4/102 Albert Road SOUTH MELBOURNE

August 2013

“Asset Classes & Performance”

Nathan Lear and Glenn Fairbairn

@ Hewison Private Wealth 4/102 Albert Road SOUTH MELBOURNE

November 2013

Topic TBA

John Hewison CEO

@ Hewison Private Wealth 4/102 Albert Road SOUTH MELBOURNE

Level 4, 102 Albert Road, South Melbourne VIC 3205 P (03) 9682 1900 | F (03) 9682 5999 info@hewison.com.au | www.hewison.com.au

The information contained in this publication is general in nature and not intended as personal advice. Please obtain advice from your financial planner before acting upon this information.