History proves time and time again that the stocks with the most upside priced in, likely fall the farthest. We see this effect in every market, including real estate and commodities.

In markets today, we are seeing some lofty valuations, as investors chase prices up, in the search for yield. With interest rates drifting lower, what premium will markets require to secure diminishing returns? At some point, the fundamental ability of a business to sustain and grow its earnings has to underpin the price we pay for these future earnings. Right now, the fluff in the market is all about the return differential to the risk free rate. So, what happens when interest rates just can’t fall any more?

It is impossible to know when markets will correct. Their fall from grace is as inevitable, as their long term rise, so should we even worry about what can happen to the paper value of our investments?

We know that if we hold through the good and bad, that we win the race, but to finish first, you must first finish. So we need strategies to be over or underweight. We must keep a quality focus, and we should question everything. In that regard, I see a lot of debate at the moment regarding active or passive investing.

We are in the mature stages of a prolonged bull market. To be fair, this market came off a very low base (the GFC); and it has been expanding on unconventional monetary policies, as Central Banks have pushed and pulled every lever to avoid a recession. But recessions are actually a necessary part of the economic cycle. They provide a cleansing fire to get rid of inefficient businesses, to open the door to new ideas and new talent. Increasingly, I hear more and more about “zombie firms” (they’re dead, but they don’t know it).

As the market grinds to new heights, it gains more support from passive index funds. You see, in a passive fund, the weight of money that pushes into the market, will find its way to the stocks that are at the time being bid to what may be illogical levels. More money pushes prices higher, the stock becomes a bigger part of the index, and more capital is thus directed toward it – it’s a virtuous circle.

Active managers will try to avoid this phenomenon, but by doing so, they appear to underperform the market. By working to steer clear of the over-inflated prices, they dwell in stocks less loved, and so their performance lags. Ironically, this leads to more money moving to passive funds, bidding higher irrational pricing, and the demise of those active managers who struggle for scale. In some ways, it too is a cleansing, as the remaining active managers are the better managers. Their opportunities amplify when the indices do finally fall, causing widespread havoc. Just as passive indices push prices higher in a bull market, they will also drag prices lower in a bear market, indiscriminately selling stocks, irrespective of their underlying fundamentals simply to reallocate their weight in those stocks to a new (lower) benchmark. It becomes the proverbial tail chase.

So – what’s the answer?

There isn’t one. Diversification is one solution. Having active and passive components and ideally the best of each. Time and fortitude are important ingredients and importantly the capacity to be brave when prices are falling. Make sure your portfolio reflects your position, one size seldom fits all. Tailoring is the solution.

Tony Munro CFPCM, Post Grad Dip. Bus.Studies (PFP), AFA, FSP 5501

The views and opinions expressed in this article are intended to be of a general nature and do not constitute personalised advice for an individual client.

A disclosure statement is available on request and free of charge.

Investors will inevitably endure uncertainty in the short-term. If you’re new to investing, then you’ve likely heard tales of “underwhelming” returns, or horror stories of investors losing large sums of capital. You may have also heard some fantastical stories of people making huge fortunes in a very short space of time. Both extremes are true, and there’s an enormous space in between.

At Munro Financial, we like to avoid extremes. Market cycles can be described like that of the passing Seasons: Without the Winter there can be no Spring, nor Summer. We’ll plan to remain invested through the “dreary” months and yet, there can be some pretty amazing periods under those darker skies. We'll hunker down when it's stormy, and we'll plant ahead of the Spring. (We yield less if we plant too late. Equally, plant too early and the frosts may take their toll). Not planting is never an option, not if we want to build sufficient stores to ensure our long-term security. Pests, fires, droughts, floods, winds, (market prices)... they're all unpredictable events that will interrupt our plans. We'll have to work through them all, and still survive.

We know that over long periods (ten years plus), there are few occasions when the return from investing in business (Share Markets) has not delivered a superior result than most other sectors. Yes, even residential real estate - if we take ‘gearing’ out of the property market, many will be surprised at how perceptions moderate. That said; there are many different markets. Within those, we will engage specific sectors to achieve a suitable spread: ‘diversification’ is the only strategy we have found, which consistently protects the investor from extreme outcomes over any period.

Some investors think they diversify by holding a multitude of companies, in the same market. While certainly less risky than holding one company, the risks to businesses operating in the same market are usually highly correlated. Conversely, an investor can spread their risks so wide that they rob themselves of the very return they wanted. We know that without risk, there is no real return, but as we age and near retirement, we will prefer a growing safety net of "low risk" assets.

Everyone is different, but we ultimately face the same challenges. To our mind, investing is personal and the typical “common or garden variety”, “one size fits all” approach has never been our preferred style. With just a bit of effort, better things can be achieved but, no matter how complex or simple the strategy, there will always be unpredictable events that can upset our plans mid-season.

Always think about your short, medium and long-term goals. We recommend developing a strategy that commits parts of your capital to those goals. In all else that we do in life, we balance off “cause and effect”, to minimise the risk of a different outcome. Investing is no different. Remember, “A goal without a plan is just a wish” Antoine de Saint-Exupéry

Tony Munro CFPCM AFA

The views and opinions expressed in this article are intended to be of a general nature and do not constitute personalised advice for an individual client.

A disclosure statement is available on request and free of charge.

Between the age of 20 and 30, most of us are just getting ourselves sorted; employment may be erratic, study could still be demanding, and life in general will be “distracting”. By our early 30’s, careers and families are cemented and we’re now in a pattern (of sorts). By our mid-60’s, we’ll have spent thirty years in and out of debt; buying houses, baches, cars & holidays… maybe even a business. If we have children, they’ll need an education and perhaps they’ll get married - we may even have grandchildren. If we reach age 65, we could make 85, and maybe older! We could easily be thirty years in “retirement” and we’ll need to rely largely on the investments we’ve made.

Financial planning often relates to retirement planning, while investment planning could be for entirely different objectives. Part of our process is to identify your financial objectives, which involves an analysis of your current financial situation and your tolerance for risk. It’s all about planning for your short, medium and long-term financial and investment goals.

Financial planning is about making financial priorities. As it stands, KiwiSaver won’t fully fund your retirement (and there’s an elephant in the room, being the NZ Universal Superannuation in its present form). Other provisions will be necessary, and so we need to figure out how to balance tomorrow’s needs with today’s demands.

Building a portfolio of investments means we’ll decide on an allocation of capital that best matches your particular future objectives, aligned to your tolerance for risk, over a specific time. We invest in different assets and sectors in varying proportions, to arrive at a “balance” best suited to meet your objectives.

We’ll prepare a tailored Statement of Advice, which formalises your goals and offers specific direction, as well as outlining the initial investment recommendations. This report will likely look to your broader financial well-being, but fundamentally, it will detail the strategy for investing, covering the four main asset sectors, being:

Cash: Money in the bank, including bank term deposits out to 90 days.

Fixed Income: Fixed income investments encompass a range of products that are intended to provide investors with regular payments of interest. Capital is repaid on maturity. Fixed income securities or bonds are typically issued by government, local authorities and companies (including banks). We may also include simple bank term deposits in this asset class. We will shy away from mortgage or finance companies, or indeed, any security with a credit rating less than A- as determined by Standard & Poors (both the issuer and the security need to be Investment Grade).

Shares: Equities provide investors with part ownership of businesses, the long-term performance of which is linked to economic growth. In general, shares are higher risk investments than cash and “Investment Grade” fixed income. Accordingly, equity returns will be more volatile; however, they do tend to provide superior returns over the long-term. We will target both local (NZ/Aust) and international shares, we may even target different speciality sectors (i.e. Healthcare, Infrastructure, Technology etc), or, specific regions of the world (i.e. USA, Australia, Asia etc).

Property: We access Real Estate investments through listed property vehicles (which provide an exposure to the underlying property assets); rather than investing in direct property, where liquidity constraints can amplify the risk of this asset class. In our view, listed property vehicles provide superior liquidity, transparency and diversification (across NZ and indeed the world), as compared with local direct property holdings. That said, we are not against direct property investments and many clients will hold these assets outside of their managed investment portfolio (still forming a part of their overall financial plan). Direct property is also often leveraged.

Once a portfolio is in place, it is important that it is monitored and reviewed on a regular basis.

In Summary, markets are dynamic and at times the portfolio will require adjustment, either to take advantage of specific opportunities, or to reduce risk, if the market fundamentally changes, or the investors priorities shift. Having the ability to “change” is a key part of the monitoring process.

We will layer a portfolio with different types of assets. We will usually underpin the strategy with a foundation of managed investment funds, either listed or unlisted, but purposefully included to provide a wider diversification. Holding a narrow concentration of direct stocks may deliver superior returns, but it likely amplifies risk. So, for most investors we’ll hope to blend specific and broadly invested listed investments with some rather special (boutique) Managed Investment schemes.

No one truly knows when the best weeks or months of the market are to be found and so, investing requires time in the markets. We may try to time the degree of our commitment into certain sectors or stocks, but we will look to remain invested throughout the economic cycle. A number of studies have been conducted, which prove over a number of time periods that if the investor is out of the market on the best ten days, over say twenty years, then the total return is around 40% lower. How can anyone know when those best ten days will be, looking ahead for the next twenty years? We’re better to be fully invested, but initially, as we start the investing process, ‘averaging in’ can provide some protection.

If you’re not planning to use some part of your capital for at least seven years, then some part of that capital needs to be invested in the capital markets. To get the best returns, we should embrace in part or full, investments that will almost inevitably experience some kind of short-term volatility. If the value of that money intended to be cashed out many years from now shifts in value today, does it really matter? If we can wait for tomorrow’s price, we may find it worked entirely as planned.

Tony Munro CFPCM AFA

The views and opinions expressed in this article are intended to be of a general nature and do not constitute personalised advice for an individual client.

A disclosure statement is available on request and free of charge.

Now is not the time to be selling or shying away from good investments. It’s a time for buying, with a cautious eye. Assets that provide us with daily liquidity are volatile, principally because “Business” is always shifting. Good management plan for highs and lows & they adjust their strategy to meet the market. Some shareholders may choose to sell, which may push prices down (but of course, someone is buying at this new price). Then, as sentiment slowly changes, prices push up as more buyers enter. The fact that we can buy or sell on any given day, reflects the more extreme shifts that can occur in listed asset prices. So ultimately, are we buying Shares, or are we buying Businesses? It is an important distinction.

The returns from Cash or Fixed Interest will never be enough to combat long term tax or inflation (I don’t see that changing any time soon). So if we’re not buying Businesses, then the alternative is to buy Real Estate and yet, that sector is by no means cheap either. Property is traditionally less volatile than Share Markets, because it does not have the liquidity of Shares. It therefore feels safer, but truly, this is illusionary. If we sell at the wrong time, this asset class is every bit as risky - indeed more so if debt has been essential to acquire the asset, and little has been repaid prior to its sale (the bank always gets its capital first).

In the short term, the only certainty is uncertainty, and therefore we do what we have always done, we diversify. We have many eggs in different baskets and we avoid mistakes. We buy what good research suggests are sustainable Businesses and we’re alert to avoid excess debt. To succeed, we develop a plan and we stick to the strategy, beyond just today’s price. Cash and Fixed Interest are short-term solutions (i.e; up to five years). Real Estate and Business are long-term investments, and while Shares and Real Estate usually outperform Cash and Fixed Deposits, sometimes they just need more time.

Extracts from Devon Funds Management December 2018 End Economic Commentary:

The US Dow Jones Index recorded its worst December since 1931 and for the first time ever, 2018 saw December deliver the worst returns of any month during the year. With headlines dominated by trade wars, a US government shut down, Brexit and the Federal Reserve shrinking its balance sheet and hiking interest rates, the Dow Jones Index finished the month down 8.7%, while Australian shares recorded their worst December-quarter since 2011. The question now is whether 2019 will prove that the recent volatility was a sign of worse things to come, or rather, this has been an opportunity.

Additionally, the potential for policy error in areas such as trade between the US and China is offering more fuel for the “Bears” out there. Unfortunately, this backdrop presented itself in not just a challenging December, but rather a tough 2018 - with almost all major stock exchanges finishing the year in negative territory. The US S&P500 closed the year down just over 6% whilst the Shanghai Index and the UK’s FTSE100 Index fell by 25% and 12% respectively. Commodities faced similar treatment with Copper down 20% and Crude Oil collapsing 24%!

The economic recovery and the financial returns that have been enjoyed since the GFC have been extraordinary, but at this juncture there is a heightened level of disagreement amongst investors and commentators as to what the medium-term outcomes will be. Although the noise surrounding international politics and central banks seems louder than ever, the fundamentals of equity markets in general appear supportive.

In closing: Investing today is about future returns. Capital to be used today should be extracted from Cash or Fixed Deposit holdings (the short-term stuff). Our “investments” are doing exactly as we’d expect, and given this most recent quarter was one of those challenging periods we’ve warned about before, now is not the time to make large reductions (indeed, this may well prove to be the best time to be buying more…).

Tony Munro CFPCM AFA

The views and opinions expressed in this article are intended to be of a general nature and do not constitute personalised advice for an individual client.

A disclosure statement is available on request and free of charge.

How would you like to see your spending in retirement?

The Westpac Massey Financial Education Centre has just released its updated annual Retirement Expenditure Guidelines, showing that for a two-person household of over 65 year-olds, the cost of a "No Frills" lifestyle (in a city) is $872p.w (costing $272p.w more than the NZ Super currently paid to a couple); or $1,399p.w for a “Choices” lifestyle (a $799p.w gap!).

The University estimates the retirement “nest egg” needed for a couple, would range from $210,000 (for a “No Frills”, provincial lifestyle) to $783,000 (for a “Choices”, city lifestyle).

Currently 12% of NZ's population is aged 65 years or older. Statistics NZ say that by the year 2030, around 25% of the NZ population will be 65 years or older. Do we really think that the NZ Superannuation is sustainable in its present form?

Most New Zealanders aspire to and achieve a better standard of living in retirement than can be supported by NZ Superannuation. So, we all need a “freehold” home and clearly $783,000 by age 65, minimum. But that $783,000 can't be sitting in an “interest bearing” bank account, it needs to be working.

Should the cost of the goods and services we require in retirement rise by an average of 4%p.a, then in ten years the purchasing power of this capital is just $520,560. Losing the spending power of $262,440 could be just as brutal as experiencing a 33% realised loss in the Share Markets. So the key is to not realise losses from investing (from having to sell in a down market), as that's a sure-fire way to reduce your lifestyle - and don't assume headline inflation is the same rate at which life's expenses in retirement are increasing by...

How to balance off the short and long-term risks is a financial planning exercise, it’s about knowing the goals and objectives of the investor and tailoring both their accumulation and subsequent drawdown strategy. So contact us today, we can help you get on the right path.

Tony Munro CFPCM AFA

The views and opinions expressed in this article are intended to be of a general nature and do not constitute personalised advice for an individual client.

A disclosure statement is available on request and free of charge.

US Tax Cuts – a global consequence...

A year on and the ‘Reality TV’ resident of the White House will be pleased with the exuberance his short term tax incentive is receiving from the Financial Markets. It’s stimulatory and it likely gives more room for the Federal Reserve to raise interest rates, as businesses keep more of the gross profit and hopefully some of that “extra” begins to trickle down to workers’ wages.

Global money seeks the best interest rate for the least risk. So, when we see higher interest rates in the USA, it’s inevitable that more capital will be pushed to that market. I believe that will accelerate the value of the USD, thus making money more expensive here (NZ & Australia). We’re not yet seeing that though, as strangely the USD has recently weakened. Picking currency in the short term is a tough job, with lots of variable components pushing perceived values in directions no one can easily predict.

Rising interest rates in the USA is surely easier for the American’s to bear, as they’ve already had a major residential property crash (GFC), during which time huge debts were written off or repaid. Consequently, the personal debt of Americans is substantially less than what we see “down under”, where we have some of the largest mortgage debt to income ratios in the World and the highest relative value Real Estate prices. Any large push on interest rates from here could spark accelerating mortgage defaults. So locally (Aust & NZ), I’m not sure we will see interest rates pushing higher any time soon.

We’re told the US tax cuts (already priced in the share market to an extent), will be a further boost to the US economy and may deliver an increase to business earnings (in the order of 20 to 25%)! Given share markets are forward pricing mechanisms, we imagine much of that hype from “lower tax” is already factored into the current share price of companies. As those benefits are actually yet to flow into the real economy, we’d say be cautious when buying shares at these levels. Prices look peaky.

The other thing with tax cuts is they’re not an entirely reliable long term source of permanent margin gain. This new upside can quickly evaporate, if new Government regulation or alternative taxes are pushed higher. Even so, they do offer an immediate boost to consumption, which will add to the party-like atmosphere we’re seeing. And just like any great party, the morning after may reveal a bigger mess than was anticipated. Let’s face it, especially if someone else is paying, a great party is fun and no one wants to miss out, but we may want a plan for how we deal with the consequence of “too much” fun.

The tax rate reduction for small to medium sized companies in the USA (aka “big” companies by NZ standards), is in the order of the difference between 36% & 21% - it’s significant for “middle” America. If we do see continued interest rate hikes, then it’s likely that pressure comes to bear on those who are most in debt, as higher rates force price rises, and that my friends is the beginning of reflation.

I don’t see a 1970’s style ‘stagflation’ (not with so much ‘technological disruption’, so many workers and global capacity), but inflation will be something more than we’ve seen for the last decade. What I do think will be similar to what we saw in the 70’s, is that house prices (in this country and I imagine Australia as well), won’t keep up with broader market inflation, and prices will adjust to a more realistic relative number. Indeed, if you think about it, the media and politicians all tell us that inflation has been muted for many years but, that is also untrue. Asset price inflation has been a very real force (housing and share markets), it’s only consumer/wage price inflation that has been extremely low (blame China).

Wage and productivity growth is what our nation needs; not rampant house price growth. Maybe the next round of inflation is precisely what the doctor ordered, to push wages higher. We then need productivity growth, not ever increasing immigration (indeed a mix of both being ideal). Unfortunately, immigration tends to pull wage growth down, as workers from countries less fortunate than our own will accept lower wages and in unskilled positions, the income gap widens.

In summary. Lots is happening out there. Markets are not cheap. So, pay down debt. Invest strategically. Do not worry if we see pull backs, they’re just a dip. Governments are committed to keeping a good party going and they’ll take a much longer view around who ultimately pays for it.

Tony Munro CFPCM AFA

The views and opinions expressed in this article are intended to be of a general nature and do not constitute personalised advice for an individual client.

A disclosure statement is available on request and free of charge.

I was fascinated when reading a recent research paper, which canvassed 161 pan-European Pension Scheme Managers, with more than 1.71 Trillion under management. The survey was followed up by interviews with thirty senior executives to obtain their detailed insights. Broadly, these “experts” felt that in terms of the investing environment immediately ahead, there was a sunny outlook with cloudy skies, but still some uncertain political risk remained.

There is much talk of interest rates rising and that this will be the start of the cause for collapse in share markets. Interest rates will rise when inflation is evident, but is inflation yet that apparent? Will interest rates move that quickly? A premature or accelerated interest rate hike could just cause a market collapse (woe betide the Central Banker that causes that)! Yet, if we think about it, the global recovery has yet to generate the actual earnings boost that could justify the current valuation in equities. For those who pull the rate hike lever (Central Banks), it’s excess earnings growth, not equity valuations, they’re concerned with.

Overall, most Pension Fund respondents agreed that while the US market looks stretched, Emerging Markets, Japan and Europe are not yet as full. The survey revealed that 95% of respondents are concerned with big market events, but that these “big” events actually only occur 5% of the time.

It’s volatility that most of us fear and that simply reinforces the case to be long term investors, to ride out the volatility. As has been said so often, timing the market is a fool’s errand. Good Asset Managers will rely on ‘diversification’ to spread risk, many will be attracted to absolute return type styles, as well as simply adopting a ‘buy and hold’ approach, for those pillars in a portfolio bought for dividend and long term earnings growth. Opportunistically, they’ll look for ‘mean reversion’ opportunities, when the price is discounted and the stock is on sale. Passive investing should be done cautiously when markets are at all-time highs, as they tend to offer little downside protection.

As an investor, a Pension Scheme has a much longer perspective than most of us and yet, anyone younger than sixty has to be planning thirty years ahead - simply to be certain of their own care (let alone investing wisely for their family who may ultimately be the beneficiary). A Pension Scheme may survive beyond thirty years, but they’re not planning that today. Their strategies will not be so dissimilar to the kind of plans any good Financial Adviser would construct for their investing client.

At a time in humanity’s history when longevity is on the rise, Shares are deemed to provide the upside to tackle the issue of purchasing power parity, but as we have said, Shares can be extremely volatile on occasion. Bonds, Term Deposits and alike, by comparison offer only a coupon and, if inflation is on the rise, it’s very possible that this type of security will not keep pace with the rising cost of living (in the long term). It is only in the short term (up to five years) that we still expect some protection to be afforded by such investing devices. Even then, this relies on selecting securities with strong credit credentials (not all “low risk” investments are safe, as some found from so-called low risk finance / mortgage company securities; while more regulation has helped clean things up, it still remains the responsibility of the Investor / Adviser to know the risks).

Back to our Pension Manager survey for 2018: Bottom line, they all agreed the old rules remain and “time in” the market, will matter more than “timing” the market, the emphasis of any strategy needs still to invest in quality assets. A timely reminder to stick to the basics when making long term investment plans, and to not be impatient or tempted by the latest craze / trend.

To our mind, investing is still a personal strategy. While the ultimate goal of investors will often be the same, the pathway to achieving the goal can vary greatly. Asset management or financial advice will vary. No one needs a one-size-fits-all approach, and much value can be added by putting in the extra yards, to tailor the approach. Long term, we do expect to deliver greater value, but acknowledge in the short term, anything can happen and risk is often as variable as returns.

Tony Munro CFPCM AFA

The views and opinions expressed in this article are intended to be of a general nature and do not constitute personalised advice for an individual client.

A disclosure statement is available on request and free of charge.

Following a recent presentation, I thought to grab a couple of very quick snippets. These are both very good examples of past returns reflecting what we can expect for tomorrow – not specifically in terms of the result, but in terms of the journey.

The first image reflects the average cash balances of Fund Managers in the US between 2001 & 2017. The idea is to match how much cash they hold, relative to the advance or retreat of the S&P500 (the index of America’s largest 500 companies). Clearly on market dips, there is more cash being held. Cash reduces and markets rally – except for 2017. This may be the Donald Trump effect. It tells me that Fund Managers remain cautious, while Mum and Dad investors are pushing more capital into the markets. That’s also a signal.

The next observation is in regard to the S&P500 itself.

Tracking from 2001, I suspect that large dip early in the piece reflects the market reaction to the World Trade Centre disaster in September 2001. There was a quick financial response and recovery, but uncertainty then took hold and markets fell back until enough confidence returned for businesses and investors to see the world again as “normal”. We then see a sustained rally.

What drove that recovery was cheap lending, over building and continued technology advancement; which lead to the next crash. The Global Financial Crisis (later to be called the Great Recession) took away all that ground (and then some more) to leave the US share market in tatters by 2009. The only worse place to have invested was housing and credit.

Then by mid 2009, on the back of an experiment known as ‘Quantitative Easing’ and a new President in the White Houseouse, the market staged a recovery. That momentum continues.

Having invested mid 2001, the investor who held their nerve through the carnage is today up 5%pa, excluding dividends. Not great, but by no means a disaster! Certainly a better result than having held a rolling Term Deposit over the same period. Being brave and buying more on the dip would have been the most ideal path forward. Sitting tight for the recovery was certainly better than selling, if it meant to realise a loss and then wonder again when to re-join, as the early gains are usually the biggest.

One more picture, shown below – a Bear Market Risk Indicator:

The blue bars are recessions, or bear markets. The graphic lines are leading market indicators. No one knows when they will turn downward, nor the speed of the downward trajectory (usually very quick). And it’s too hard to tell if it’s a permanent shift down, or just another tweak before reaching new heights.

We can see two very large recent “tweaks” in 2000/2001/2002 and then again in 2007/2008/2009. Remember 1987 – the great share market crash?… It’s the thin blue line between 1980 and 1990 – a small tweak, on the way to all new highs.

The other point on this table is to question if we are nearing the next “big” tweak. There does seem to be a natural ceiling to these things and today we’re approaching it, and yet – the travel from here to the highest point could still well be some very high returns. We also know that the alternative places to invest are equally as expensive (real estate, fixed interest) and we know that if inflation is on the way back, then cash is not a long term friend.

So what to do?

Above all else, we must buy quality that will last the test of time, not be over-weighted (if we can’t cope with the volatility), and be well-diversified.

And one final point - “passive” investing rides the wave up and down, “active” offers a chance to step off.

Tony Munro CFP AFA

The views and opinions expressed in this article are intended to be of a general nature and do not constitute personalised advice for an individual client.

A disclosure statement is available on request and free of charge.

The culture of large asset gatherers (banks) is very different to small advisory firms. Often both will have some very good people working for them, but generally front line staff in the larger institutions won’t have any say over policy or procedure.

As a small business owner, my clients talk to the Managing Director every day. I have a vested interest in their success. There are no bonuses if sales take precedence over prudent advice, indeed there is a contingent liability if we’re not delivering the best solutions and you simply cannot leave a problem behind or pass it on to someone else. My business relies on good outcomes for our “client”. “Customers” won’t roll through the door every day indeed, we pick them as much as much as they pick us. It’s personal, the advice and the service.

Our business is successful because we tailor our approach to asset selection & portfolio management. We access many of the same tools and research channels as the bigger institutions. We attend the same conferences and lectures, but we can differentiate and capture diverse solutions from different suppliers. We can pick the "best in class", without compromise.

Recently I read a report from one of the big four banks, which conveyed data about their most popular investment fund. The managed fund in question has $561 million under management and there are 2,360 investors. The average balance: $240,000 (talk about “one size fits all”!).

Like an old Model T Ford, their investors can have any colour they like, as long as it’s black!

Staying with the car analogy, would you rather an Audi, BMW, Holden, Ford or Skoda? What’s the price/quality point? The price you pay for an Audi is likely a lot more than the Skoda. Is quality better in the Audi? Unlike motor cars, financial instruments/platforms largely cost the same to buy and run, so as investors, why would we limit ourselves to a Skoda, when for the same money, we could have the Audi? P.S. Skoda and Audi are made by the same company.

Most bank-managed investment funds will do no harm because fundamentally, they’ll be moderate. It’s less important to a bank to be first, than to be worse than the next bank. When customers leave the bank, they tend to take all their business so it’s “safer” to be “average”.

I work for clients. As the business owner, my skin is in their game. If we lose a client, I take it personally. To be fair, we don’t lose clients because we put them first. We’re small, boutique and intimate. It’s about personal relationships and working hard to always deliver the best option.

If a particular institution’s Managed Fund is judged to be the best in its class, then the independent financial advisor will have little hesitation investing in that same fund. If the advisor is tied to a particular brand, this may limit what they can do - which is not to say that tied financial advisors won’t do their best, but their options are limited. If as a profession we are committed to putting our client’s interests first, how is that best done if you can’t be independent?

Big institutions are a valuable part of the financial advisory world, but they are the Model T Ford. They are usually a cookie cutter and their solutions are entirely appropriate for a section of the community, especially those getting started. But, there comes time when we each want a better vehicle, where it can be purpose built and tailor-made to what we want and need.

Only good advice should be dispensed by a qualified and competent adviser in NZ, irrespective of where or for whom they work. Being independent means we try to meet our client’s needs from the available solutions… and in our experience, it just works better.

Tony Munro CFP AFA

The views and opinions expressed in this article are intended to be of a general nature and do not constitute personalised advice for an individual client.

A disclosure statement is available on request and free of charge.

I recently completed an interesting exercise, comparing some figures I stumbled across from three years ago. There’s lots of numbers I know, but I thought some would find this interesting…

Relative to three years ago, all Markets (except Emerging), on a Price to Earnings (PE) basis are on average today, more expensive on a rolling twenty year basis.

NZ’s market is 22% more expensive than we were three years ago. Our gains are by far and away the most impressive, though all markets have risen. Europe has been the laggard. Today the world PE trades at 16.1x. The average of the last twenty years is 15.7x. Given where interest rates are, relative to the last twenty years, this doesn’t feel dramatically excessive.

And then there’s the NZD story. Shown below is the NZD relative to the USD, AUD, EUR & GBP over the last 5 years:

Tony Munro CFP AFA

The views and opinions expressed in this article are intended to be of a general nature and do not constitute personalised advice for an individual client.

A disclosure statement is available on request and free of charge.

The problem for us humans, is that we’re hardwired to react strongly to negative signals. When we invest, if we see the value of our investments dropping, a loss is a very amplified emotion. We are far less emotional about a win, than we are a loss.

Share markets are a price-setting machine. They are the place that buyers gather, to acquire from sellers, assets that will make the buyer or seller wealthier (or that’s the plan).

Often investors forget that when share markets are falling, someone is still buying. It’s the last trade which resets the lower price. Some investors are momentum followers and as Mother Nature instils in us a fear of loss, we’d rather move with the crowd and also sell. There is no "fight" – the only logical reaction is "flight"! As long as everyone is a loser – we’re less of a loser.

Looking now at market values, we’re a long way from the last big slump. We’re almost 10 years from the ASX’s all-time high, which incidently was followed by the Global Financial Crisis. So, should we be worried? Is the next BIG fall, moments away? Who knows – but I can tell you, worry is a wasted emotion and price weakness in a quality business is an opportunity to buy.

Australia’s economy has had a boom of 25 years, yet on average “recessions” are supposed to happen every 7 years. Our Aussie mates are about 18 years late for a nasty market event. So, what to do? We’ll, we could make the same agreement about NZ's Alpine Fault. It’s also overdue for a large release - so we should all move to Australia, right?

Most days, someone somewhere is predicting a crash. Eventually they will be ‘right’. Yet still $10,000 invested in 1986 became $150,000 by 2016, despite all of the stuff that 30 years of the worst (and best) of the economy and geopolitics could throw at it (the ‘87 stock market crash, two wars in Iraq and one in Afghanistan, the collapse of the Asian share markets, Russia defaulted on its debts, the dot.com boom and bust, large-scale terrorism in the US, UK and Bali, and, yes, the GFC). The average return from Australia was 9.6% p.a, a 15-fold return on investment through holding the index.

With hindsight, we know precisely when to enter and exit the market but at the time, no-one knows. One of the world’s great investors, American Fund Manager, Peter Lynch, captured the idea nicely: “It’s a great feeling to be caught with your pants up.” In other words, being fully invested means you get the benefit of the gains, when they come.

In a perfect world, we’d invest when the market was going to go up, and sell when it was about to go down. This isn’t a perfect world, so we do the next best thing: invest anyway, and stay invested. BUT, don’t invest capital in the share market (or anywhere else) if you need that money back in the next 3 to 5 years. Market slumps do happen and you don’t want to be forced to sell an investment at the wrong time.

In summary, history shows the share market has wonderful, diversified, wealth-building potential, but from time to time, it will smash results into little pieces. Investors need to take care to invest prudently and ideally with a strategy designed to build wealth around their particular circumstances. This is where a qualified and professional financial adviser can help. Having a tailored approach to your Portfolio Construction will make a difference, so do get good advice.

Tony Munro CFP AFA

The views and opinions expressed in this article are intended to be of a general nature and do not constitute personalised advice for an individual client.

A disclosure statement is available on request and free of charge.

I saw an interesting article from Warren Buffett recently. He challenged a group of Active Fund Managers to do better than putting money in a passive indexed fund. The challenge was accepted. Buffett invested passively & left the Active Managers to their own devices. Buffett won, with no effort.

It's a very interesting debate… one I’ve heard since I was at University back in the early nineties. To be fair, there are always two sides to every story, but if we had to agree on one, we’d surely back the Oracle of Oklahoma (Mr Buffett). That said, I have some sympathy for the Active Managers and besides, isn’t Berkshire Hathaway (Buffett's company) an "active" investor?

85% of Fund Managers won't beat the market in the long term (we're talking about world markets). What Mr Buffett doesn't explain well, is that investors lose confidence at different times and they lose the most confidence when markets are in trouble. If I recall, the article mostly talks about the "average" and as I said, I agree that 85% of Fund Managers will not beat the market!

It's interesting that the race Mr Buffett had with those Hedged Fund Managers (Hedge Fund Managers are a different breed anyway), came to an end when share markets just happened to be at all-time highs. In that regard, Mr Buffett had very good timing (he made the bet when things were starting to recover). He’s been around long enough to know it was likely a “safe bet” and, he was taunting a group of managers that tend to have a rather high opinion of their own ability.

Here's what Mr Buffett doesn't say; market results are not linear and investors may spend a lot of time feeling lost and distressed by these results when it’s not going that well. So, when the heat is on, many investors will exit and realise a loss. They may hope to come back in when things have recovered but, we all know that’s a fool’s errand. Active Managers can insulate this to a degree and they certainly do make it easy to invest (not everyone is an experienced investor).

Investing takes patience & fortitude, which comes with time and knowledge. Very often, investors sell or buy at the wrong times. Only hindsight proves when the best time actually was (this is true even for Fund Managers, who are the “supposed” experts). I said to someone recently: How can anyone have lost money, if every five years or so the share market is at another "all time high"? It sounds so easy, and when we're looking backward from a great advantage point (as we are in the USA today), it's easy to agree with Mr Buffett but, when we're at the bottom of the cliff just after the market tipped us over the edge, most wish for a better crystal ball or an “active” Fund Manager that was “underweight” in the markets before they fell, and minimised the loss.

This debate about "active" vs "passive" will be calmed when the market next falls, because good Active Managers “should” hold their ground better than the index. However today that may mean those Active Managers will struggle to outperform that same index. If we think about it, when the market is racing ahead and the “expert” we pay to guide us is fearful that stocks are now expensive, surely they will invest more capital into cash or alternative assets? Therefore, it stands to reason that they will “underperform” the market (because they’re not fully invested). The idea is, when the market does fall the Active Manager’s return may not fall as far, providing they’ve invested well. Their recovery may then also occur sooner, or at least that’s the plan.

In 2017, markets are at an all-time high & indices have outperformed most managers, but not all active managers are investing actively away from the index. The majority still hug the index.

Remember, nearly all Fund Managers are “active” managers. Indices are not people, they’re the market. As an Investment Advisor, we choose which Managers to engage. Indeed I would suggest that most Fund Managers don’t get onto our recommended product lists. When the next big fall in markets occur, these active index huggers (the 85%) will likely fall by the same degree as passive funds and in that regard, the investor paid active fees for passive performance.

Is now the time to be investing in Passive/Index funds?

In most of our strategies the dominant global managers deployed have been Platinum and Magellan. Both are "active" and both have underperformed global share markets at different times recently. Here are the facts:

Fund (to 31 May 2017) 1 year 3 year 5 year 10 year

Magellan Global 12.9% 15.3% 18.8% 11.5%

Platinum International 17.8% 12.4% 17.2% 8.0%

MSCI – Index (passive) 14.3% 13.4% 17.5% 4.7%

The fund performance is pa after fund manager fees. The MSCI is the index. However a passive index fund like say a Vanguard Global fund would have the performance of the index but fees of between 0.2% - 0.4% would yet need to be paid.

The post fee returns between the “active” managers we deployed and the “passive index” against which they are measured, are very close. In that regard, there isn’t a lot of return “value” added by the “active” managers these last five years and so why would investors pay higher fees to have an “active” manager if there is so little in it? I’d suggest that not all “active” managers are equal.

We know markets move in cycles and a cycle is usually three to five years. If we look past the last five years (to ten years) and take into account a couple of the big market falls that happened, we can better test, if “value” was added by our managers. Look at that ten year number on the far right (above). It’s fairly compelling and remember, it’s post fees. Magellan is the clear winner (by some degree), but past returns are no guarantee of future returns.

Can we be sure that our “active” choices will perform over the next ten years? No! We can conclude that some Active Managers do earn their fee, despite what the media says but, it takes time for that to reveal itself - just as Berkshire Hathaway took 51 years to prove Warren Buffett had a talent for picking good businesses (but you know, he didn’t always get it right either).

Platinum have been the prominent Active Manager I’ve used since 1995. They have been in my portfolios to varying degrees for twenty two years. Very often they have not been the best performer – as evidenced these last ten years (Magellan beat them convincingly, though they still achieved a return after their fees, which was nearly double that of the passive index alternative).

While we can’t predict what tomorrow brings, we can show what has historically been the result for our investors who followed our advice into a fund twenty two years ago (as compared to a passive index fund):

Fund 22 years Value of $100,000 invested

Platinum International (since inception) 12.88% $1,437,388

MSCI – Index (passive) 6.63% $ 410,531

Returns are net of management fees but before tax (if any) and in these examples, reported in AUD

This debate is historical; we now need to concern ourselves with what will happen tomorrow…

In Summary

I believe we should have both active and passive strategies in our portfolio. We engage a number of direct share investments; so, is that approach “active” or “passive”?

We tend to buy and hold quality companies (shares) and in that regard, it is passive, but we then have the concentration risk of investing in those businesses, which I’d suggest is more active.

We have had very good and measurable success from this approach of engaging direct shares and it suits the many professional people for whom we act but, I’m beginning to give stronger thought to capturing more “passive” funds – more index related holdings. I’m also a little fearful around the timing of that exercise because, while we acknowledge that passive funds charge fees which are approximately a quarter of the active managers, the evidence above still supports active managers, if we get our Fund Manager selection right.

We can’t guarantee that we can pick them right all the time and we also know that the bigger the active manager gets (the more funds under management they have), the less they seem to outperform their relative index. Size begins to hamper their ability to be nimble. So, it’s complicated and even then, there are exceptions (Warren Buffett’s a fairly good example of an “exception”).

We do need to have a number of different investment baskets, all working together for the benefit of our investor and there are many parts to managing an effective portfolio.

One final thought…

A year ago the MSCI (Morgan Stanley Capital Index) – against which most international Fund Managers measure themselves, reflected the US share market as representing 52% of that index by itself (NZ makes up just 0.50% of the world index).

As at May 2017, the US share market now represents 59% of the world index and almost every commentator agrees, one of the most expensive share markets in the world today is the USA! Many also agree the USA has still much opportunity ahead and so, we are in the very normal position of not really knowing if prices are now “too cold”, “too hot”, or “just right”.

In the context of the last six years (current bull market), one does have to wonder if the majority of the return from this “cycle” has already occurred? So, are we still content to be in an investment vehicle that places nearly 60% of the underlying investment emphasis into expensive US shares?

The argument around “Active” or “Passive” is good to have and for investors to have choice is better still. In that, I’m looking at index funds (ETF’s) as an option to gain a cheap exposure to a market; and thinking of places such as India, or sectors such as Healthcare or where we may find Disruptive Technology. Maybe an “active / passive” option is a better strategy, if we still believe it’s possible to get an edge by doing good research, or by simply still having a strong gut feeling.

In conclusion, I think there is room for both Active and Passive, but when perfect hindsight reveals that over a decade, the active manager we engaged delivered a return of 10%p.a (after fees of 1.5%p.a) and the passive index which charged way less (0.20%p.a) delivered 5%p.a, the debate quickly dies… except to acknowledge; “Past returns are still no guarantee to future returns”.

Tony Munro CFP AFA

The views and opinions expressed in this article are intended to be of a general nature and do not constitute personalised advice for an individual client.

A disclosure statement is available on request and free of charge.

I’ve been speaking with some younger people recently, a number of them the family members of existing clients. Some are looking for investment options, but a number have been asking questions about real estate - about buying their first home. They’re asking how to do it, when to do it, indeed should they do it? They’re all very good questions.

Today I won’t go into the detail of the grants and access available from programs such as KiwiSaver, but will share with you a slide that recently came to my attention which reminded me to be cautious. This image was buried in a much broader document from Deutsche Bank. The heading on the page that grabbed my attention in this regard was:

It’s a bold statement and one that pushes back against most Canadian home owners. The researcher is actually lobbying for an interest rate hike, to punish home owners. Yikes!

I recall Canada has some of the most expensive house prices in the world, but clearly things have got more expensive since I last looked. So, I turned the page with intrigue, knowing how insane our prices have become and hoping to see the Canadian’s were more nuts than us.

The page that followed reflected data from twenty different nations. Guess who was at the top? Yip, New Zealand’s house price/income & house price/rent is 73% overvalued!

73%!! As a nation I know we need to build something like 30,000 homes to meet current and expected immediate population growth. It’s a big number and so simple rules of supply and demand dictate that an extreme shortage creates an extreme demand and what usually follows is irrational pricing.

No one should root for a housing market collapse. It takes years to recover such events (just ask anyone from Europe, Japan or the USA). So if our children are to ever afford to own their own home “New Zealand needs higher, not lower interest rates” but the concern is what would that mean for our exchange rates and our ability to sell our goods and services overseas? So we steal from our children their option to buy as we did. One could argue their opportunities and choices are greater in others areas. The trick is to keep looking forward.

Conclusion: If you are buying your own home and you intend to stay there for many years, if your job is secure and if you haven’t borrowed too much then it doesn’t really matter what housing does but, any uncertainty around these factors then, at these levels do be cautious.

I manage and advise on investment portfolios. Ensuring clients avoid permanent financial harm has to be the most important part of my job. If I can be of service to your family, even if it is to refer them to specialists I trust on matters or risk management (insurance) or gearing (mortgages), do please have them contact me. On investing, I especially enjoy those calls.

Tony Munro CFP AFA

The views and opinions expressed in this article are intended to be of a general nature and do not constitute personalised advice for an individual client.

A disclosure statement is available on request and free of charge.

I’m not going to talk about China, US interest rates, oil, inflation, deflation or the price of fish. I’m going to talk about the sky falling or rather, it isn’t.

We invest in share and real estate markets with a long term view. We never invest with a six month view or indeed, a three year view, yet we all want positive returns in six months (and certainly in three years). As we know, investing can bring times when things just don’t work out as we planned.

We want to invest in companies or managers that show the greatest potential to outperform over the long term - that means “outperform” their peers in the long term. Do we really care what happens in the short term? I guess we do, because it can create much uncertainty and that can lead to bad decisions. So, we try to avoid fads, we try not to follow the crowd. We work for our clients.

Irregular trends

Markets have been irregular (if there is ever such a thing as a ‘regular’ market!), because the shares and sectors that performed badly in previous years continued to underperform, while the shares that previously performed well continued to outperform. This is known as market trending. Generally last year’s winners don’t tend to perform as strongly in the following years; they simply don’t have the capacity to produce the same amount of performance. Equally, some businesses have strong growth and can continue to grow for a very long time. So on dips, we should seize the opportunity to increase the holdings in our favoured shares, while prices are lower than we imagine they should be. This approach reduces our average purchase price and increases the likelihood of a long term positive return. It’s neither gambling nor guess work and it is a brave investor who invests on a falling wave, yet history proves this is when the best returns are made… maybe not that particular year, maybe not even in three or four years, but in the longer term the certainty of doing well increases.

Fact

A good business with defendable cash flows and future earnings growth will be worth more in the future, but their share price today will be determined by the sentiment of sellers today and in that environment, the difference between real value and perceived value can be dramatically different.

Sitting on the right side of the fence

When market expectations are low the situation only needs slight improvement for share prices to rise. For shares trading on high valuations, the good news is already in the price and so a slight reversion means the price could tumble. We would much rather sit on the side that shows potential for significant price rises, not limited upside. But I confess, we can feel disheartened if the anticipated results take longer than planned (the price today still being set by what sellers are willing to accept, irrespective of what tomorrow brings).

Onwards and upwards

Today in the media we see lots of speculation. There are more ‘Bears’ (pessimists) than ‘Bulls’ (optimists). We have had five straight years of substantial gains, so not only is it normal for a pull-back but indeed, maybe desired. Valuation “bubbles” are not good for anyone, and in the long term they tend to lead to deeper recessions.

So, are markets over-valued? The ones that appear this way are bond markets (fixed interest) and residential property (if we are talking NZ). The NZ share market looks as highly valued as any in the western world (not as high as our real estate). I saw someone quote in the media recently the old: “return of capital is more important than the return on capital”. Hey I agree, but over what time frame?

As a practitioner, I don’t usually make short term predictions, because it is impossible to say exactly which shares will rise and which will fall, or when. We focus on the long term, what can be delivered over five years or more. Deep trends are what we look for, solid foundations and sensible diversification.

Our portfolios have endured periods of underperformance before and it will happen again. That’s the nature of investing; we have to suffer short-term pain for long-term gain. Over the long term, we expect outperformance. Don’t get me wrong, when I review the last month’s results there are a few in positive territory, but most are down slightly. When I review the last twelve months (including December and January) everyone is substantially ahead. So this is a message about sticking to the plan. Don’t ignore the Bears but, take some of what they ‘sell’ with a grain of salt.

We will continue to deliver over the long term, and in the short term we will seek to separate risks.

We will not put at risk all of an investor’s capital. If they have stated that they need to draw on that capital in the near or medium term, we will provision for that but, if it is only a part of their capital that is needed then, what of the next five, ten or twenty years? Will it matter in September 2024 if stock markets were down briefly in 2016? Maybe it will – but more likely, it won’t!

Financial markets were down (and some substantially) in: 1987, 1990, 1992, 1994, 2001, 2002, 2007, 2008 and 2011. Had we known we could have sold and been side-lined, but the problem then becomes; “when do we re-enter”? You see, after each of these falls financial markets did not just rise a little, they went substantially higher! And then down, and then up, and then down, and then up. But point to point over the long term, where do you imagine the investors who bought quality ended up?

If we miss the first few days of the rally, we’ve missed most of the recovery. Timing is everything and it is impossible. Sure, sometimes we get it right but usually, it is degrees of wrong. All we can precisely know ahead of time is what precisely happened yesterday. No one truly knows what tomorrow brings (despite what you read in the newspapers) and so, we have to plan for possibilities. Conversely, if we knew with complete certainty that the only way was up, we’d have everything in the market.

Good portfolio management is about the degree that we are “in” or “out”; but we’re not traders - that’s gambling! As investors, we acknowledge that sometimes we may choose to keep extra in cash or fixed income, especially if we feel more anxious about the immediate future, or if we know we need to be so positioned because our client’s circumstance is where the anticipated volatility or change is likely to occur.

The management of the degrees of exposure is what we call “Asset Allocation”. Scientifically we know over the long term we can more precisely predict the average annual return and likely volatility. The question should never be; “how we are positioned when markets are falling or rising”? The important question is; “are we positioned to best reflect our client’s personal circumstances”? Then, good investment selection is a natural extension of good portfolio management and timing won’t matter.

Tony Munro CFP AFA

The views and opinions expressed in this article are intended to be of a general nature and do not constitute personalised advice for an individual client.

A disclosure statement is available on request and free of charge.