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Volatile Markets: A FinSec Comment

Global shares had a bumpy couple of weeks, as strong economic data and corporate earnings were offset by geopolitical concerns. Most major markets had a positive start to the week as investors regained their composure after last week’s sharp sell-off, with many indices posting their largest one-day rallies since March.

What caused the sharp sell-off?

The main reason underpinning the pullback was a response to concerns that rising interest rates (increasing bond yields) in the U.S. would cause a national or global slowdown.

This compounded with rising US – China trade tensions and other macro-economic news from around the world caused the market to ‘connipt’.

The obvious question is, what now?

Should inflation and wages in the U.S. surprise on the upside then the Fed may be forced to move rates more aggressively, this would definitely not play out well for equity markets. We continue to monitor risk and retain our view that whilst a cautious stance is warranted, we do not expect “the sky to fall” anytime soon. What we do expect is a choppy period of consolidation as markets come to terms with the normalisation of rates in the US.

If you have any questions regarding the recent market developments or your portfolio positioning, please contact your adviser.

For more regular updates please click here to ‘opt-in’ to receive our weekly market update.

Transferring your UK Pension to Australia: Eligibility Criteria

In the last couple of years the rules around transferring UK pensions to Australia have changed significantly. These changes have added a layer of complexity and many migrants and returning expats remain confused with regard to what pensions can and can not be transferred. In this post we outline the current eligibility criteria, for more information on UK Pension transfers visit www.finsecptx.com.au

ELIGIBILITY CRITERIA ONE:  YOUR AGE
  • Under current rules you must be aged 55 years or over to transfer UK pensions as a lump sum to Australia.
  • If you have a funded Civil Service/Public Sector Pensions that is eligible for transfer (for example: Local Government Pension Schemes and Universities Super Schemes (USS)) you must complete the transfer before turning 60 years old. From time to time transfers can be subject to UK administrative complexities, to this end we advise commencing the transfer process at least 6 – 9mths prior to your 60th birthday.
ELIGIBILITY CRITERIA TWO: YOUR PENSION FUND

Please Note: UK State Pensions (Old Age Pensions – from your National Insurance contributions) CANNOT BE TRANSFERRED as a lump sum (i.e. are not eligible for transfer) – here is a link to find your State Pension Information.

UK PENSIONS ELIGIBLE FOR TRANSFER
Company Pension Funds  Eligible only if pension payments have not yet commenced.
A Company Pension Scheme (otherwise known as a Workplace or Occupational Pension) is a pension that is set up by your employer to provide retirement benefits to you while you are employed by them.
Personal Pension Plans  Often eligible only if pension payments have not yet commenced.
A personal pension is usually arranged by yourself, not your employer, and is a type of money purchase plan.
Funded Civil Service Pensions Eligible only if pension payments have not yet commenced.
Funded Civil service Pensions include;
  • USS (Universities Superannuation Scheme)
  • LGPS (Local Government Pension Schemes)
Flexi Draw Down Pensions The majority of draw down pensions are eligible for transfer even if pension payments have already commenced.
UK PENSIONS NOT ELIGIBLE FOR TRANSFER
All Government State Pensions A British State Pension is also know as a Government Pension or Old Age Pension. Your entitlement to this pension accumulates during your lifetime and is paid by the UK Government when you reach state pension age, which depends on your date of birth.A state pension value is based on the number of years of National Insurance (NI) contributions made throughout a person’s working life. You have to have at least 35 qualifying years’ worth of NI contributions to qualify for a full State Pension.

*All government state pensions are not eligible for transfer to Australia.

A Fund that has Commenced
Annuity Payments
Excluding Draw Down Pensions
Unfunded Civil Service Pensions  Including:
  • NHS
  • Teachers
  • Fire Fighters
  • Police
  • Armed Forces

The 19 Questions to Ask your Financial Adviser

The 19 Questions to Ask Your Financial Adviser

The Wall Street Journal (one of our favourite places to ‘hang out’ online) has compiled this list of “best duty” questions to ask your financial adviser. Although very American it is thought provoking none-the-less and in our view Australian Advisers should be just as happy to answer a similar set of questions with context – I know we are! Please note both the questions and answers are from the original Wall Street Journal Article (using the American context).

THE 19 QUESTIONS TO ASK YOUR FINANCIAL ADVISER

Getting all stockbrokers, financial planners and insurance agents to act in the best interests of their clients is a struggle that financial firms and their regulators still haven’t resolved. That should be their job — but for now, it’s yours (the investor).

The obligation of those who give investment advice to serve clients, not themselves, is called fiduciary duty. That obligation is far from universal and, in some ways, is in retreat.

Until regulators and trade groups sort things out — and the next total solar eclipse may come first — the burden of finding someone who will act in your best interest is on you.

That means asking an adviser the right questions (and listening for the best answers). I encourage you to clip or print out this column and bring it to your next meeting with your financial adviser.

1. Are you always a fiduciary, and will you state that in writing? (Yes.)

2. Does anybody else ever pay you to advise me and, if so, do you earn more to recommend certain products or services? (No.)

3. Do you participate in any sales contests or award programs creating incentives to favour particular vendors? (No.)

4. Will you itemise all your fees and expenses in writing? (Yes.)

5. Are your fees negotiable? (Yes.)

6. Will you consider charging by the hour or retainer instead of an annual fee based on my assets? (Yes.)

7. Can you tell me about your conflicts of interest, orally and in writing? (Yes, and no adviser should deny having any conflicts.)

8. Do you earn fees as adviser to a private fund or other investments that you may recommend to clients? (No.)

9. Do you pay referral fees to generate new clients? (No.)

10. Do you focus solely on investment management, or do you also advise on taxes, estates and retirement, budgeting and debt management, and insurance? (Here the best answer depends on your needs as a client.)

11. Do you earn fees for referring clients to specialists like estate attorneys or insurance agents? (No.)

12. What is your investment philosophy? (They should have one)

13. Do you believe in technical analysis or market timing? (No.)

14. Do you believe you can always beat the market? (No. But we believe that ‘active management’ is the best way to maximise returns)

15. How often do you trade? (As seldom as possible, ideally once or twice a year at most.)

16. How do you report investment performance? (After all expenses, compared to an average of highly similar assets that includes dividends or interest income, over the short and long term.)

17. Which professional credentials do you have, and what are their requirements? (Among the best are CFA [Chartered Financial Analyst], CPA [Certified Public Accountant] and CFP, which all require rigorous study, continuing education and adherence to high ethical standards. Many other financial certifications are mmarketing tools masquerading as fancy diplomas on an adviser’s wall.)

18. After inflation, taxes and fees, what is a reasonable estimated return on my portfolio over the long term? (If I told you anything over 3% to 4% annually, I’d be either naive or deceptive.)

19. Who manages your money? (I do, and I invest in the same assets I recommend to clients.)

Source: The Wall Street Journal, http://on.wsj.com/2wC3zFk

Weekly Market Update – 19th May 2017

Weekly Market Update

Investment markets and key developments over the past week

  • Most global share markets fell over the last week on the back of the political crisis around President Trump. US shares fell 0.4% after recovering some of their losses later in the week, Eurozone shares fell 1.1%, Japanese shares fell 1.5% and Australian shares fell 1.9%. Australian shares are now down around 4% from their high earlier this month and have been hit by the weak global lead combined with pressure on the banks as a result of the Budget’s bank levy along with expectations for slowing credit growth and weakness in retailers on the back of weak retail sales and fears around the competitive threat from Amazon. Chinese shares managed to buck the global trend and see a 0.6% gain. Reflecting the risk off environment bond yields generally fell, but commodity prices mostly rose helped by a falling US dollar. The weaker US$ and good jobs data also helped support a small bounce in the A$.
  • The standard narrative right now seems to be that the ‘Trump trade’ drove the surge in global share markets since the US election and that this will now reverse because of the political crises surrounding President Trump. In our view this may be a little too simplistic. First, the main reason for the rally in shares since last November has been the improvement in economic conditions and surging profits that has occurred globally and not just in the US and which had little to do with Mr Trump. Second, the political crisis around the President won’t necessarily stop the pro-business reform agenda of the Republicans. In fact, unless things become terminal for Mr Trump quickly it’s more likely to speed it up. There is no doubt the political risks around President Trump worsened over the last week with increasing talk of impeachment and concern that it will impact the Republican’s tax reform agenda. However, it’s a lot more complicated than that:

    First, impeachment is initiated by the House of Representatives and can be for whatever reason the majority of the House decides and conviction, removal from office, is determined by the Senate and requires a two thirds majority.

    At present Republicans control the House with a 21 seat majority and won’t vote for impeachment unless it’s clear that Mr Trump committed a crime (and so far it isn’t obvious that he has) and/or support for him amongst Republican voters (currently over 80%) collapses.

    However, Mr Trump’s overall poll support is so low that if it does not improve the Democrats will gain control of the House at the November 2018 mid-term elections and they will likely vote to impeach him. Then it’s a question of whether Mr Trump can get enough support amongst Republican Senators to head off a two thirds Senate vote to remove him from office.

    This is all a 2019 and beyond story, but the point is that Republicans only have a window out to November next year to get through the tax cuts/reforms they agree with Mr Trump should happen. So if anything, all of this just speeds up the urgency to get tax reform done because after the mid-terms they probably won’t be able to.

    Now there is another way for the Vice President and Cabinet to remove a President from office under the 25th Amendment of the Constitution which is aimed at dealing with a President who has become mentally incapable. While some may claim this one is a no brainer, Vice President Pence is a long long way from doing this.

    The bottom line is that while the noise around President Trump and particularly the FBI/Russia scandal will go on for a while it does not mean that tax reform is dead in the water.  On this front work on tax reform is continuing including in the Senate and Mr Trump’s infrastructure plan (which is likely to be around leveraging up Federal spending and encouraging states to privatise their assets and recycle the proceeds) looks likely to be announced soon.

  • Share markets have had a great run and are due a decent 5% or so correction as a degree of investor complacency (as indicated by an ultra-low VIX reading two weeks ago) has set in and the latest scandal around President Trump may just be the trigger. North Korean risks are another potential trigger and after all it is May (“sell in May and go away”). Australian shares are down 4% from their high early this month, but global shares are only down 2% or so. However, providing the current Trump scandal largely blows over for now allowing tax reform to continue it’s unlikely to derail share markets beyond any short term correction. Valuations are reasonable particularly for share markets outside the US, global growth is looking healthier, profits are rising (by around 14-15% yoy in the US and Japan and by 24% yoy in Europe) and global monetary conditions remain supportive of shares.

  • It seems to have been a week for political scandals. Aside from those around President Trump, a corruption scandal has engulfed Brazilian President Temer highlighting that big risks remain around Brazil and allegations have emerged regarding Japanese PM Abe (although he is likely to survive them).

Major global economic events and implications

  • US economic data was mostly good. Housing starts fell in April but driven by volatile multi units and a further increase in the already strong NAHB homebuilders index points to strong housing conditions going forward. While the New York regional manufacturing conditions index fell in May it rose in the Philadelphia region and industrial production rose sharply in April. Meanwhile, jobless claims remain at their lowest since the early 1970s. All of this is consistent with the Fed hiking rates again next month. The political noise around President Trump will only impact the Fed if shares and economic conditions deteriorate significantly and that looks unlikely.
  • The Japanese economy accelerated to 0.5% quarter-on-quarter in March driven by consumption and trade taking annual growth to 1.6% year-on-year. This was the fifth consecutive quarter of growth, the first such run in 11 years.
  • Chinese data for industrial production, retail sales and fixed asset investment slowed in April consistent with other data indicating that recent policy tightening is impacting. Our view remains that GDP growth will track back from March quarter growth of 6.9% year on year to around 6.5%. The Chinese authorities have little tolerance for a sharp slowing in growth and policy makers are already showing signs of easing up on the policy brake. Meanwhile property price growth seems to have stabilised around 0.5% a month over the last few months, but is still slowing in Tier 1 cities.

Australian economic events and implications

  • Australian data was mixed. Jobs growth was strong again in April and forward looking jobs indicators point to continuing strength ahead, but consumer confidence fell and wages growth remained at a record low of just 1.9% year-on-year.
  • While the good jobs numbers will help keep the RBA on hold for now regarding interest rates the continuing weakness in wages growth is a concern and highlights ongoing downwards risks to growth, inflation and the revenue assumptions underpinning the Government’s projection of a return to a budget surplus by 2020-21. With unemployment and underemployment remaining in excess of 14% it’s hard to see what will turn wages growth up any time soon. So while our base case is that interest rates have bottomed, if the RBA is going to do anything on interest rates this year it will more likely be another cut than a hike. Particularly if property price growth slows.

What to watch over the next week?

  • OPEC meets Thursday and is likely to extend its oil supply cuts in the face of rising US shale oil production. OPEC is in a bind: if it cuts supply further it will lose more market share to shale oil but if it hikes production oil prices will plunge again.
  • In the US, in the week ahead expect the minutes from the last Fed meeting (Wednesday) to remain consistent with another rate hike at the Fed’s June meeting and the Markit manufacturing conditions PMI for May (Wednesday) to show a slight improvement from April’s reading of 52.8. New home sales (Tuesday) and existing home sales (Wednesday) are expected to fall back slightly after strong gains in March, home prices (Wednesday) are expected to show a further gain and April durable goods orders (Friday) are expected to remain consistent with continued reasonable growth in business investment. March quarter GDP growth (Friday) is likely to be revised up to 0.9% annualised from an initially reported 0.7%.
  • In Europe, expect May business conditions PMIs (Wednesday) to remain strong consistent with stronger economic growth.
  • Japanese core inflation for April (Friday) is expected to remain around zero consistent with the Bank of Japan maintaining a zero 10-year bond yield and quantitative easing for a long time.
  • In Australia, March quarter construction data is expected to show continued softness in mining related engineering construction but gains in residential and non-residential construction. Speeches by RBA officials Debelle, Bullock & Richards will be watched for any clues on interest rates.

Outlook for markets

  • Shares remain vulnerable to a further short term setback as we are now in a weaker seasonal period for shares with risks around President Trump, North Korea, Chinese growth and the Fed’s next rate hike next month providing potential triggers. However, with valuations remaining okay particularly outside of the US, global monetary conditions remaining easy and profits improving on the back of stronger global growth, we continue to see any pullback in shares as an opportunity to “buy the dips”. Shares are likely to trend higher on a 6-12 month horizon.
  • Low yields and capital losses from a gradual rise in bond yields are likely to see low returns from sovereign bonds.
  • Unlisted commercial property and infrastructure are likely to continue benefitting from the ongoing search for yield, but this demand will wane as bond yields trend higher.
  • National residential property price gains are expected to slow, as the heat comes out of Sydney and Melbourne.
  • Cash and bank deposits are likely to continue to provide poor returns, with term deposit rates running around 2.5%.
  • For the past year the A$ has been range bound between $US0.72 and $US0.78, but views remain that the downtrend in the A$ from 2011 will resume this year. The rebound in the A$ from the low early last year of near US$0.68 has lacked upside momentum, the interest rate differential in favour of Australia is continuing to narrow and will likely reach zero early next year (as the Fed hikes rates and the RBA holds) and constrained commodity prices will also act as a drag. Expect a fall below US$0.70 by year end.

Source: AMP CAPITAL ‘Weekly Market Update’

AMP Capital Investors Limited and AMP Capital Funds Management Limited Disclaimer

FinSec Partners Disclaimer

Into the Unknown

Into the Unknown: Key Takeaways

PIMCO recently published its Cyclical Outlook for global growth, inflation, trends and transitions likely to affect the investment landscape in 2017. Below are some key takeaways:

With Trump, Brexit, Italy’s “No” vote and China’s currency woes, the world economy and markets have embarked on a journey into the unknown. As coauthor Andrew Balls and I noted, the only certainty in our view is that the “tails” in the distribution of potential macro outcomes have become fatter – i.e., more extreme scenarios, which usually have a low probability of taking place, have become more likely.

The downside, or left-tail, risks are defined by rising debt, monetary policy exhaustion and the populism-powered transition from globalization to de-globalization. By contrast, upside, or right-tail, opportunities may emerge from potential deregulation, awakening animal spirits and the accelerating transition from exhausted monetary policy to growth-supportive fiscal policies.

Three key macro transitions in 2017

The path for the economy and markets will likely be determined by how three difficult transitions play out on the cyclical (six- to 12-month) horizon:

  • The transition from monetary to fiscal policy, which has gained speed with the European Central Bank tapering the monthly run-rate of its asset purchases to €60 billion, the Bank of Japan abandoning its money supply target in favor of a yield target, and the next U.S. administration likely to embark on a more expansionary fiscal policy.
  • The transition from globalization to de-globalization, which has been underway for some time but looks set to accelerate as governments in the U.S. and elsewhere will likely become more inward-looking.
  • China’s currency regime transition from what was a U.S. dollar peg until August 2015 to the current quasi-basket peg to what may become a managed or even free float of the yuan.

Investment implications

Investors should consider a patient approach and aim for capital preservation until the veil of uncertainty over future policies starts to lift. With markets prone to overshooting and undershooting and likely to swing back and forth between our secular New Neutral and a potential “New Paradigm,” better opportunities to deploy liquidity should emerge in the course of 2017.

Joachim Fels is PIMCO’s global economic advisor and a regular contributor to the PIMCO Blog.

Fels_JoachimAUTHOR: JOACHIM FELS

Federal Budget 2016/17 Our Verdict: The Less is More Budget

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Scott Morrison’s maiden budget speech was the first since Peter Costello’s debut 20 years ago that did not include the word ‘surplus’ an unreported, but perhaps telling, fact. It is no secret that the 2016 Federal Budget made negligible progress on improving Australia’s bottom line. Projecting a small surplus way out in 2020/21 it has experts concerned about the future of Australia’s AAA credit rating. But, to its credit, this pre-election budget didn’t make things worse. Debt accumulation seems to be held and (retrospective super tinkering aside) policies are, for the most part, “harmless”.

So let’s talk motive for this seemingly benign budget. ‘Quintessentially political’ and a ‘bow to the altar of fairness’ is, of course, the popular view. Morrison claims it is all about the economic plan and, more specifically, Australia’s transition from the mining investment boom to a more diversified economy. This is a formula he hopes will restore credibility in terms of both the Coalition’s promises and their traditional strength of economic management.

True motive unknown, one thing is certain: the government wants this budget to appear calm on top while working hard underneath. The judgment here is less about ‘who’ the government has gone after and more about its modest proposals. And with the word ‘surplus’ conspicuous by its absence, perhaps debt is one of the driving forces behind this modesty.

A debt of global proportions

The world is staggering under a record amount of debt. Household, corporate and government debt are at unmatched levels in absolute and relative (to GDP) terms. According to a McKinsey Global Institute report on debt levels across 47 countries, it is estimated that global debt soared from US$142 trillion (A$187 trillion) in 2007 to US$199 trillion in 2014. Over these seven years, the ratio of debt to global output climbed from 269% of world GDP to 286%.

The report found that, over the past seven years, no major economies and only five emerging countries, (Argentina, Egypt, Israel, Romania and Saudi Arabia) have reduced relative debt. Concurrently, 14 countries boosted total debt by more than 50 percentage points. During this period, Australia’s total debt climbed 33 percentage points to 213% of GDP. The report also found that household debt has climbed to concerning levels in Australia (no surprise), Canada, Denmark, Malaysia, the Netherlands, South Korea, Sweden and Thailand. China has a special case of debt addiction all of its own. From 2007, Beijing instructed state banks to commence a lending frenzy that resulted in total debt jumping 82 percentage points to 217% of output (and more recent studies put it at 240% of GDP).It is no surprise that all this debt poses an unprecedented threat to the world economy and long-term financial stability. The probability that vast sums of the money will never be repaid (and will need to be written off) is high. Such an outcome could trigger systemic banking failures and, as the saga of Greece shows, without a global mechanism for dealing with sovereign default, any government bankruptcies will be messy.

But there is a flip side to debt. Borrowing is not a bad thing in itself and, in fact, debt is often referred to as the lifeblood of capitalism: the driving force that has lifted living standards for decades. At a micro level, debt enables people, companies and governments to manage cash flows over time. Sovereign debt, in most cases, provides investors with haven investments. Governments can safely borrow unceasingly if their fiscal deficits, as a percentage of GDP, are below the rate of economic growth. The problem is, there is no definitive point where debt can be categorised as ‘too high’ and hence ‘too risky’. It’s a balancing act and, at some point, the accumulation and risk have to be managed.

Is there a solution?Current policy makers are tasked with the desperate need to devise new solutions to dilute the threat from too much debt. This is particularly so since much of the collateral people and companies have borrowed against are assets priced at apparently unsustainably high values.

The difficult task for policy makers now is to curtail debt the “right way”. The worst action they could take would be to taint debt as “bad” and encourage excessive repayments. This would serve only to threaten the consumption and investment needed for a functioning economy. Take, for instance, the experience of the Eurozone: austerity measures shrunk economies faster than they reduced debt, entrenching deflation and boosting the real value of debt. The fact is most Governments, households and businesses can manage their debt loads, provided economies continue to hum. Which brings us back to Morrison and his Budget.

Whether it was intentional or not, there is an underlying pragmatism that should be acknowledged. The proposed measures are certainly in sync with a strategy that aims to keep an economy ‘humming’. Debt accumulation is stabilised, with no demands for a return to surplus (over the short-medium term) and is therefore, void of those pressures. Morrison does not want a nation of panicked people. Ask ordinary voters if they are better or worse off as a result of this budget, and the answer is likely to be “no change”. Gone are the messy policy thought bubbles such as a higher GST, cracking down on negative gearing excesses, or major income tax changes. Most of those “bubbles” have been comprehensively pricked. This is a budget that, on the surface, the government wants perceived as tough on its own base, not ordinary taxpayers. But at a deeper level, is possibly more economically calculating and strategic than many give it credit for.

Will it be enough to ensure the re-election of the Coalition for a second term? We will have to wait and see. Of course the opposition and some segments of the media have it destined to an unhappy fate, but despite their best efforts this budget seems to have achieved the rare feat of keeping the harmful blows at bay. Perhaps in doing less, Morrison may actually have achieved more.

Click here to read our Budget Report

2016/17 Federal Budget Report

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Excerpt: 2016/17 FEDERAL BUDGET REPORT

May 2016

For us, the big story out of Budget 2016 is of course Morrison’s crackdown on high-end super tax concessions. Ten years on from Costello’s tax-free super savings and now, on the other side of the resources boom, Morrison has redefined the purpose of super as a substitute or supplement to the welfare safety net of the aged pension, not a vehicle for wealth accumulation or bequests.

Whilst we welcome the fairness measures and in particular applaud those initiatives that help low-income earners and those with low superannuation balances, we do not look favourably on any announcement that proposes change retrospectively or that may be counterproductive to a person’s ability to save for a secure and dignified retirement.

It has now been three weeks since Budget night, but three eventful weeks in the context of understanding the motives and the landscape surrounding the proposals. We have heard from the various sides of the election campaign and now have a sense of what will go through and what might be ‘retrospectively argued away’.

As is customary at FinSec, we have opted to wait and deliver a succinct report, focusing only on the information relevant to the financial advice we provide. As always, if you have questions relating to your personal circumstances, we encourage you to contact us so that we can discuss the proposed changes in greater detail. But do not forget, at this stage the proposals are only announcements a lot may change as the legislation navigates both an election and the political process thereafter.

UK Pension Transfers: Industry Wide QROPS Issue

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STOP-PRESS: On July 1 2015, HMRC re-published its ROPS (Recognised Overseas Pension Scheme) list, stripping all Australian QROPS schemes of their QROPS status (with the sole exception of the Local Government Superannuation Scheme).

HMRC made this decision in the belief that Australian funds are unable to comply with the new QROPS requirements because of their overarching obligation to comply with Australian legislative requirements.

As a result, all UK pension transfers have been placed on hold to minimise the risk of unauthorised payment penalties (up to 55%) for customers. However, we are still accepting DCFs to facilitate those wishing to join our subscriber list to access the most up-to-date information on this issue. DCF processing will resume once the QROPS issue is resolved.

This complex issue has already been raised at an industry level with the Australian Treasury. And as PTD continues to provide input to both HMRC and the Australian Treasury over the coming weeks to facilitate a positive outcome for all, we will also continue to keep you up to speed with the latest developments as they unfold.
agoodmove.com.au

Another 21 Great Investment Quotes

Investing can be profitable as well as fun, but it can also be unnerving and unprofitable if you don’t understand markets and don’t have the right mindset. The basics of successful investing are timeless and some experts have a knack of encapsulating these in a way that’s insightful. A year ago Shane Oliver wrote on 21 investment quotes he finds useful (see 21 great investment quotes), here are some more…

Invest FinSec Partners 2015 April The View

The market and cycles

“The stock market is the story of cycles and of the human behaviour that is responsible for overreactions in both directions.” Seth Klarman

Cycles are an investing reality. Not just shares – but also bonds, property, infrastructure, term deposits, whatever. They all go through cyclical phases of good times and bad which are driven by the combination of fundamental economic & financial developments invariably magnified by investor behaviour that has a habit of extrapolating current conditions into the future. Some cycles are short term, such as those that relate to the 3 to 5 year business cycle. Some are longer, such as the secular swings seen over 10 to 20 year periods in shares.

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“In the old legend the wise men finally boiled down the history of mortal affairs into a single phrase: ‘This too will pass.’” Benjamin Graham

Just as historical experience tells us there are investment cycles, it also tells us that they pass. Despite all the “new eras”, “new paradigms” and “new normal” commentators wheel out at cycle extremes, all cycles contain the seeds of their own reversal. When someone tells you about a new whatever, it’s probably already run its course. So when, after a major share market collapse in the midst of recession, it seems there is no hope, just remember “this too will pass.”

“It’s so good it’s bad, it’s so bad it’s good”. Anon

In every cycle there comes a point where fundamental conditions are so good that they are bad: economic growth is so strong that its causing inflation to rise and central banks to run ever tighter monetary policies; shares have become overvalued; and investors have piled in at such a rate that there is no one left to invest. This then sets up a market top and a new bear market. And the reverse applies during economic and market downturns. Which brings us to contrarian investing.

Contrarian investing

“The way to make money is to buy when blood is running in the streets.” John D Rockefeller

This is a bit extreme, but it illustrates a key point. The best time to buy shares and other growth assets is after a sharp fall and a good guide is the economic and financial pain around you. When it is at an extreme and it all looks hopeless then that’s usually a good sign that there is long term value to be found!

“Markets are in a constant state of uncertainty and flux and money is to be made by discounting the obvious and betting on the unexpected.” George Soros

There are two insights in this. First, markets are always bouncing around – minute by minute, day by day, year by year – because they are trying to discount the future. We just have to get used to it. Second, investment markets can be perverse. If the economy and profits are obviously bad then that is likely already reflected in the share prices and you are better off betting on what is not, eg an economic recovery. And vice versa when things are obviously good.

“In investing, what is comfortable is rarely profitable.” Rob Arnott

The problem with contrarian investing is that in going against the crowd you lose that warm fuzzy feeling that comes with safety in numbers. You have to go against what you are hearing at BBQ’s or from the media and that can be very uncomfortable.

“The share market’s role is to make the majority of investors wrong” Ned Davis

This sounds rather bleak and is a bit simplistic, but it reflects the fact that most don’t invest on a contrarian basis – by definition markets top out when most investors are long and they bottom when most are short or underweight. Hence the comment about the market proving the majority of investors wrong. There are two ways around it: either adopt a contrarian approach which takes positions counter to the crowd at extremes or take a long term approach that looks through cyclical fluctuations. But whatever you do don’t get sucked in (or out) when everyone else is.

Pessimism

“More than any other time in history, mankind faces a crossroads. One path leads to despair and utter hopelessness. The other to total extinction. Let us pray we have the wisdom to choose.” Woody Allen

I love this quote. Because often the financial commentary around investment markets can only see disaster. Eg, we have been inundated with commentary over the last five years to the effect that the Eurozone will soon blow itself apart or that if it stays together it is doomed to a horrible outlook. And yet not only has it stayed together but it has got bigger!

Process

“A great company is not a great investment if you pay too much for the stock.” Benjamin Graham

The key to successful investing is not to buy great companies or investments, but to invest well. Shares can give you horrible returns if when you buy they are overvalued and overloved. So you need an investment process that avoids this.

“When the facts change I change my mind. What do you do sir?” John Maynard Keynes

This is the classic economists’ defence for when their forecasts don’t pan out! But it also highlights that any investment process needs to have a bit of flexibility for when the facts change.

“Don’t look for the needle in the haystack, just buy the haystack!” John C Bogle

The key insight here is that trying to beat the market by stock picking can be hard and so if you want to grow wealth over time the key is to get a broad exposure to the market and letting compound interest do its job.

“There seems to be a perverse human characteristic that makes easy things difficult.” Warren Buffett

Whatever you do, don’t overcomplicate your investments. Avoid investments you don’t understand and try and keep your investment process relatively simple and commensurate with the amount of effort you want to put in. You need to be able to see the wood for the trees and understand what’s happening.

“There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know.” J.K. Galbraith

While that may be a bit harsh – you might say I would say that being an economist – the reality is that forecasts as to where the share market, currencies, etc, will be at a particular time have a dismal track record. Hence the jokes about economists! Good experts will help illuminate and point you in the right direction, but don’t over rely on expert forecasts.

“Stop trying to predict…” Warren Buffett

Basically, the same point. If you are going to actively move your investments around the key is to have a process that helps identify extremes – when assets are undervalued, underloved and oversold and vice versa. Or if you don’t have the time or inclination to put the effort in, it’s best to take a long term approach and let others manage cyclical market fluctuations.

Cash flow and time

“Do you know, the only thing that gives me pleasure? It’s to see my dividends coming.” John D Rockefeller

There have been lots of investments over the decades that have been sold on promises of high returns or low risk but were underpinned by hope based on hot air (the tech boom) or financial alchemy (AAA rated sub-prime trash). By contrast, assets that generate sustainable cash flows (dividends, rents, interest payments) and don’t rely on excessive gearing or financial engineering are more likely to deliver.

“Our favourite holding period is forever.” Warren Buffett

In investing time is on your side and the more you have of it the better. So while short term market fluctuations can take you away from your objectives – think the first chart in this note, the longer the perspective you take the great the chance you have of achieving them – as per the next chart.

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Right mindset

“In the business world, the rear view mirror is always clearer than the windshield.” Warren Buffett

We are all subject to behavioural biases, the most serious perhaps being a tendency to extrapolate recent developments off into the future regarding investment returns. So if the recent past has been poor you assume this will continue and want to get out and vice versa. But this just causes us to get wrong footed by the cycle. Just as spending too much time focussed on the rear view mirror will get you wrong footed by the road.

“You get recessions, you have stock market declines. If you don’t understand that’s going to happen then you’re not ready, you won’t do well in the markets.” Peter Lynch

If you can’t handle volatility associated with investment markets then either they are not for you or you should just take a long term approach and leave it to someone else.

“Individuals who cannot master their emotions are ill suited to profit from the investment process.” Benjamin Graham

This is all about knowing yourself. The reality is that we all suffer from the behavioural biases that give too much weight to recent developments in forming expectations regarding future returns, seek safety in the crowd and give too much weight to loss relative to gain. But smart investors have an awareness of their weaknesses and seek to manage them. One way to do this is to take a long term approach to investing. But this is also about knowing what you want to do. If you want to take a day to day role in managing your investments then regular trading may work, but you need to recognise that this requires a lot of effort to get right and will need a rigorous process.

Reality

“There is no free lunch.” Anon

If an investment looks too good to be true in terms of return or risk, then it probably is. Rather, focus on investments offering sustainable cash flows (dividends, rents, interest) that don’t rely on excessive gearing or financial engineering.

“Money can’t buy me love.” The Beatles

And finally, just remember that money isn’t everything. Numerous studies show that people with good wealth and incomes are happier than those without, but beyond a certain level more money won’t necessarily make you any happier.

Dr Shane Oliver
Head of Investment Strategy and Chief Economist AMP Capital

AMP CAPITAL Disclaimer

The Trowbridge Report

Life Insurance is a large and very important part of Australia’s financial sector.

According to assistant Treasurer Josh Frydenberg “there are 28 life insurance companies writing more than $44 billion worth of business, and more than 13,500 life insurance advisers employed in Australia.” The policies they provide – be it through a superannuation fund, direct from an insurer or via a financial adviser – provide essential financial security in the event of death, serious illness or injury. Without it, even the best laid plans often go awry.

However, it has become clear through a series of reviews that reform in the sector is needed.

The latest of these reviews, an independent report by John Trowbridge and one commissioned by the industry itself, focuses yet again on the misalignment of interests that can occur between insurers, the adviser and the client.

Like the Murray Report before it, Trowbridge’s main concern is upfront commission and the issue of ‘churning’. His report outlines six policy recommendations for improvement.

  1. Upfront commissions be replaced by level commissions combined with an
    initial advice payment (to cover policy set-up) that can not be paid more than
    once every five years (‘the five year rule’).
  2. A transition period of three years in the implementation of point 1.
  3. Licensees be prohibited from receiving non-commission benefits from insurers that might have an impact on the products they recommend to their clients.
  4. Licensees to extend the number of providers on their Approved product list to include at least half of the providers servicing the market.
  5. Improve the standards of client engagement and education
  6. The industry to develop a ‘Life Insurance Code of Practice’ to better inform and govern adviser customer interactions.

Click here to read the full report 

FinSec Partners have long championed the raising of professionalism in financial planning, particularly the banning of conflicted remuneration and the requirement for advisers to act in the best interests of their clients. In this context, we welcome the Trowbridge Report .

Whilst the report (at this stage it is only a report, not law) addresses key issues within the risk industry and to this extent should be applauded, the current recommendations do require considerable ‘tuning’ to ensure the desired outcomes are in-fact achieved. We hope the 5 year rule allows the flexibility to deliver ‘best interest’ advice in-line with a persons changing needs and that any savings to manufacturers as a consequence of reform, is passed directly on to consumers, not pocketed as additional company profits.

Most in the industry would agree ‘churn’ should be prosecuted but not when the recommendations are in danger of helping large integrated insurers on the back of the sins of so few.

A step in the right direction none-the-less.