The Debt Crisis 2007/2008

Report
Simple Steps to Financial Success
in the Current Climate
Tuesday 1st December 2008
Scott Francis
&
Scott Keefer
Who are we?
• Principals and owners of a ‘fee – only’ financial planning
practice
• Scott Francis
– MBA, M Com and M Fin Plan degrees
– Regular Contributor to Alan Kohler’s Eureka Report
– Author of the Book ‘A Clear Direction – Being a Successful CEO of
Your Life’
• Scott Keefer
– M Fin Plan, B Com, Grad Dip Ed
– Candidate in the Chartered Financial Analyst (CFA) program
• Authorised Representatives of FYG Planners Pty Ltd
– Australian Financial Services License Number 224 543
Overview of the Presentation
Tonight we plan to cover the following topics:
• The habits of building wealth
• Building an investment portfolio
– 3 key decisions
• Asset allocation
• Active v Passive investment approach
• A brief synopsis of the current market situation
and the impact on building portfolios
Our Website
www.acleardirection.com.au
You can sign up for our free fortnightly email
newsletter:
www.acleardirection.com.au/sign_up_for_email_newsletter
A copy of this presentation will be available at:
www.acleardirection.com.au/ieee
General Advice Warning
‘The information in this presentation is
general in nature – and has not taken into
account the personal circumstances of
anyone attending the seminar.
You should check the information with a
professional prior to taking any action.’
The Habits of Building Wealth
• Spending less than you earn (manage your cash flow).
‘The Millionaire Next Door’ (Stanley and Danko) (Most
common millionaires car – Ford Ute; don’t spend more
than $200 for a watch; and ‘Affluenza’ (Hamilton and
Denniss)
– affluenza, n. a painful, contagious, socially transmitted
condition of overload, debt, anxiety and waste resulting from the
dogged pursuit of more. (de Graaf, 2002)
– affluenza, n. 1. The bloated, sluggish and unfulfilled feeling that
results from efforts to keep up with the Joneses. 2. An epidemic
of stress, overwork, waste and indebtedness caused by dogged
pursuit of the American Dream. 3. An unsustainable addiction to
economic growth. (PBS)
• Investing regularly over time (build passive investment
earnings)
The Habits of Building Wealth
• Invest in growth ‘ownership’ assets (choose to invest
part of your money in ‘higher risk’ ‘higher reward’
opportunities)
• Minimising fees and taxes
• Thoughtfully selecting investment opportunities
• Allowing investment earnings to compound over time
(fees and taxes directly reduce compounding) – not
chopping and changing
– THIS IS WHERE STARTING EARLY CAPTURES THE UNIQUE
OPPORTUNITY OF COMPOUNDING
‘In the world of capital markets there are four key inputs
required by business to create wealth. These inputs are:
• Resources (the material inputs involved in business)
• Intellectual Capital (the ideas and innovation behind
business)
• Human Capital (the people who work in the business)
• Investment Capital (the money provided for use in
business)
As an investor, you are providing a key input into
this process, the investment capital, and as such
you are entitled to a successful investment
experience.’ (Investment Philosophy – A Clear Direction
Financial Planning)
Dilbert’s 9 Steps to Managing Money
Dilbert’s 9 Steps to Managing Money
1. Make a will.
2. Pay off your credit cards.
3. Get term life insurance if you have a family to support.
4. Fund your 401(k) to the maximum. (Superannuation)
5. Fund your IRA to the maximum. (Superannuation)
6. Buy a house if you want to live in a house and can afford it.
7. Put six months expenses in a money market account.
8. Take whatever money is left over and invest 70% in a stock index fund
and 30% in a bond fund through any discount broker and never touch
it until retirement.
9. If any of this confuses you, or you have something special going on
(retirement, college planning, a tax issue), hire a fee-based financial
planner.
Scott Adams – “Dilbert and the Way of the Weasel”
Cash
• Traditionally bank accounts/cash management
trusts
• Now ‘e accounts’
• No Risk of Capital
• Income based on interest rate in the economy –
income in the form of interest payments
• Current cash rate 4.75% to 6.25%
• Long term average return since 30 June 1970
9.6% BUT now in a lower interest rate
environment
Fixed Interest/Bonds
• You ‘loan’ your capital to a bank, Government or company in return
for a series of interest payments and the return of your capital at a
future point in time
• My opinion: You should not take risks with this portion of your capital
– do this with your ‘growth’ or ‘ownership’ investments
• Well regarded ratings system in place: Standards and Poors – rates
fixed interest securities from AAA AA A BBB (last of the investment
grade ratings)
• Average long term return since 30 June 1970 9.7%
• In some ways the most difficult asset class to navigate because there
is such a variety of opportunities
Australian Shares
• You become part owner of a company/portfolio
of companies
• You benefit from the payment of ‘dividends’ and
the growth in value of the underlying company
• The average return since 30 June 1970 has been
13% a year
• Some 1,400 companies listed on the Australian
Stock Exchange
International Shares
• You become part owner of a company/portfolio
of companies outside of Australia
• You benefit from the payment of ‘dividends’ and
the growth in value of the underlying company
• The average return since 30 June 1970 has been
13.6% a year
• The Australian share market makes up less than
2% of the value of listed companies worldwide
Listed Property Trusts
• Listed on Australian Stock Exchange
• Underlying Assets are Commercial Style Property
(shopping complexes, office trusts, industrial property,
entertainment)
• Generally pay strong income (7% plus); growth at or
slightly above inflation
• Average return 14% a year since 1980
• The sector is changing – greater use of debt; greater
‘construction’ risk
Direct Residential and ‘Other’ Asset Classes
• Other includes: ‘Art’, ‘Taxi Plates’, ‘Wine’, ‘Agricultural’,
‘Hedge Funds’
• Keep in mind diversification: Easy to be overly exposed
to residential property
• ASX and Russell Survey of 20 year investment
performance shows direct residential property returning
12.1% a year to end December 2005 (survey available
on the ASX Website under the title ‘Long Term Investing
Report 2005’)
• For the purposes of this presentation – which is limited
by time we will not consider these areas of investing
further.
Decision 1
Defensive Assets vs Growth (Equity) Assets
Decision Criteria:
• Timeframe (how long is the portfolio for)
• Liquidity (how easily do I need to access money
and how much money MIGHT I need)
• Risk Tolerance
• Experience (understanding of risk)
Growth Assets
• Australian Shares
• Listed Property Trusts
• International Shares
What is an Index?
• Collection of all of the assets in an investment
universe. For example, the ASX200 measures
the investment performance of the biggest 200
investments on the Australian Stock Exchange.
• Usually weighted by size. For example, BHP has
a much higher index weight than Flight Centre;
The movement in price of BHP are more
important to the overall index that the
movements in price of Flight Centre.
Investment Fees
• Commissions and Structural Corruption in the
Financial Planning Industry
• Think in % to see how fees erode your
investment returns: Think in $ to see if you are
receiving the service that you deserve
• Fees are a risk free investment cash flow (away
from the investor)
Active Versus Passive Management
• Active Management – ‘normal’ for the investment
industry: Assumes some level of skill or
knowledge that nobody else has that will allow
a person to ‘beat’ the market.
– Stockbrokers
– Managed Funds
– Traders
• Passive Management – Investing in index funds
or passive funds that replicate some portion of
the investment universe passively (i.e. without
research or assuming skill). E.g. small
companies fund
Active Appears Intuitively Smarter
• Why shouldn’t people have the skill and ability to ‘beat’ the
market?
• The market return is good, a better than average market
return is better….
• BUT: There are costs involved in active management that
reduce the expected market return (trading costs and
research costs). This reduces the average return of the
market.
• If everybody expects to beat the average return on the
market, then more than half (because of trading and
research costs) are going to be disappointed. Is there
overconfidence at work here?
Passive (eg Index Funds) Does Have
Some Advantages
1) There is very little trading, so trading costs are
low. (this includes the ‘market impact’ cost of
trading)
2) Passive funds tend to be low cost (less than
half the price of an active fund) because there
is no money spent on research
3) Passive funds are extremely well diversified
because they hold all the investments in an
index
Evidence Active vs Passive
• Dr Rich Fortin and Dr Stuart Michelson, both
finance professors, authored a paper in the
September 2002 Journal of Financial
Planning entitled ‘Indexing Versus Active
Mutual Fund Management’. (A mutual fund is
another term for a managed fund). They found
that, in both before tax and after tax terms:
– Index funds outperformed managed funds for most
share based categories and all fixed interest
categories.
– Active management did not add value
• David Gallagher and Elvis Jarnecic, from the University of New South
Wales, have authored two papers that look at the performance of
Australian managed funds that invest in international assets and fixed
interest assets.
• In the article ‘The Performance of Active Australian Bond Funds’,
published in the December 2002 Australian Journal of
Management, they found that there was ‘significant
underperformance for retail bond funds after fees’.
• In the article ‘International Equity Funds, Performance and Investor
Flows: Australian Evidence’, published in 2003 in the Journal of
Multinational Financial Management it was found that ‘active
management (ie in managed funds) does not provide investors with
superior returns to passive indices’.
• In reviewing the literature concerning managed funds Gallagher and
Jarnecic found that ‘…the empirical evidence widely documents the
inability of active fund managers to outperform market indices’, with
‘Australian research also supporting this international evidence’.
• Two economics professors from the University of Queensland,
Michael Drew and Jon Stanford, examined the returns from
superannuation investments.
• In a paper published in the September 2003 edition of the
Service Industry Journal, entitled ‘Returns from Investing in
Australian Equity Superannuation Funds, 1991 – 1999’, they
found that ‘the average superannuation fund, specialising in
the management of domestic share portfolios, underperforms
passive market indices by about 2.8 to 4% per annum.
• Their overall conclusion was ‘Australian superannuation
investors would achieve their retirement income objectives
more rapidly by engaging a low cost fund manager employing
a passive technique (ie indexing)….’.
• It is interesting to note that most of our superannuation assets
are managed in active managed funds.
• Dr Ross Miller, a finance professor from
the United States, in his paper ‘Measuring
the True Cost of Active Management by
Mutual Funds’, considers the returns from
152 managed funds from January 2002 to
December 2004. On an overall basis the
152 mutual funds underperformed the
index by an average of 1.5%.
Individual Investors
• Two University of California Professors,
Brad Barber and Terrance Odean, studied
35,ooo households with discount
brokerage accounts from 1991 to 1997.
• They found that trading destroyed value
for investors: Trading reduced
– men’s portfolios by 2.65% a year, and
– women’s portfolios by 1.72% a year
The Question of Persistence?
• Mark Carhart, in his paper ‘On Persistance in Mutual
Fund Performance’ published in the Journal of Finance
in 1997 found that there was no evidence of persistence
in the performance of managed funds. (1962 – 1993:
1,982 equity funds)
• Sawicki and Thomson, in their paper ‘An Investigation
into the Performance of Recommended Funds: Do
Managed Fund ‘Approved’ by Research Companies
Outperform the Non Gratea (non approved)? also found
that there was no evidence of ‘persistence’ of returns.
Every US large cap fund with a 15 year history vs the S&P500 and
CRSP 1-10 indexes. 15 Years ending 31 December 2001 (285 Funds)
Annual returns of “buy and hold” index vs actual annual
returns enjoyed by US mutual fund investors from 1984 to
2002
14.00%
12.22%
11.70%
12.00%
10.00%
8.00%
6.00%
4.00%
4.24%
2.57%
2.00%
0.00%
US Stocks
Index
US Bonds
Mutual fund investor
Source: DALBAR, Inc. Media release of 2003 update of “Quantitative Analysis of
Investor Behaviour” study.
The Role of Luck
• There are more than 9,000 managed
funds in the Australian investment
universe (less than 2,000 listed entities on
the ASX……)
• Over time some are bound to outperform
Building a Passive Portfolio
• Asset Allocation is the Key
• Passive Funds available from:
– Vanguard
– Global State Street (through platforms)
– Macquarie
– Virgin Superannuation
– Colonial
The idea of an Efficient Market
• An efficient market is one where all stocks
are fairly priced according to publicly
available information – such an
environment would support the use of
indexing as the prudent investment
approach
• Note that no-one is saying that the market
is perfect: just that it is efficient
The Current Market
As at the end of November 2008
(Year on Year % change)
– ASX All Ords
– S&P 500
– Dow Jones
– Nikkei 225
– FTSE100
– Shanghai Composite
-44.3%
-39.5%
-34.0%
-45.7%
-33.3%
-61.6%
Four Key Factors
•
In looking at the current situation and
prospects going forward we think there
are 4 key factors to consider:
a)
b)
c)
d)
The Credit Crisis
Fears of a Recession
Forced Selling / Fear Selling
USA Home Prices
Credit Crisis
• Since the fall of Lehman Brothers, financial institutions
have been extremely hesitant to loan to each other which
has forced up interest rates for inter bank loans
• The recent problems for the Citi group has added some
more uncertainty
• The signs are that borrowing rates are coming down as
measured by LIBOR (London Inter Bank Offer Rate)
• It has taken some extreme government action but the
signs are positive
Fears of a Recession
• This now seems to be the key issue weighing on
investment markets
• The National Bureau of Economic Research in the USA have
today announced that the downturn commenced in
December 2007. This already makes this US recession the
3rd longest since the Great Depression
• The good news for Australia is that current indications are
that our economy will continue to grow through the end of
2008 and into 2009 (OECD, IMF, Aust government)
• Company profits up to the end of September have actually
been stronger than expected
Fears of a Recession
• However, we are not immune from global woes, some
economists predict Australia may already be in recession
• Wednesday’s GDP figures will provide some clarity to the
picture
• Governments around the world are lowering interest
rates and announcing stimulus plans to counteract these
fears
• The big unknown are the large amounts of consumer
credit and the impact of unemployment on the ability to
keep paying off this credit
Recessions and Share Markets
• One interesting point to note is that on average
through history, investors start to factor in an
economic recovery about ½ way through a
recession which leads to rising share prices.
This continues as an economy picks up steam.
• With some experts suggesting the recession will
continue through to the middle of 2009, this
may place the US past the ½ way point.
Forced Selling
• This is the most difficult factor to judge
• There is clearly still fear around (VIX Index at historically
high levels)
• Margin calls are still being made
• Reports are that hedge funds have been selling down to
accommodate redemptions
• However, some good news came through last week in
that we saw net inflows into stock mutual funds in the
US compared to net outflows in previous weeks.
(www.cnn.com)
US House Prices
• The US Housing market is where the current problems
began and any improvement here will be a boost to the
US and global economies
• The latest data shows home prices are down 17.5%
across the 20 largest US cities to the end of September
(S&P/Case-Shiller Home Price Indices)
• However, recent moves by the US Treasury and Federal
Reserve are likely to lead to significant reductions in
mortgage interest rates
• This should help to put a floor under home prices and a
floor under the securities that have caused so much of
the problem
What is Priced Into Shares?
• There is an obvious desire to sell shares, and
put the money into cash at such a difficult time.
However, the price of shares at the moment
must reflect a great deal of fear.
• The value of shares at the moment would likely
reflect:
– The USA recession
– Continued problems in credit markets
– A slow down in company earnings
Strategic Decisions for Investors
• Keep a reasonable level of cash
• Diversification is a positive strategy
(avoid collapses like MFS,
ABC Learning, Macquarie Fortress Notes, Asset Loans, Babcock and Brown, Basis Capital,
Absolute Capital, City Pacific, MFS Premium Income Fund, Centro Property………………)
• Aggressive Long Term Investors – possibility to
buy in a distressed market (but a strategy with
risk)
• Keep an eye on the ‘income’ from investments –
Australian shares are paying a dividend yield of
greater than 6%; that is very attractive
Double or Nothing – Eureka Report article
• Also on our website is an article written by Scott
Francis published in Alan Kohler’s Eureka Report
online newsletter
• A link can be found at the seminar materials
page – www.acleardirection.com.au/ieee
• The article looks at:
–
–
–
–
Investing regularly into shares
The mortgage is cheaper
Salary sacrificing
Building a passive income stream
Questions?

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