Before closing the office for the holiday season break, we sent out a final piece of communication to our clients with a report we completed looking at Australian share income as compared to income received from cash over time.

Over time there are two benefits that we hope to receive from investing in shares.  The first is that we hope that the shares we own will go up in value over the long term.  As a statement of the blindingly obvious, this has not been happening in the short term.  The second benefit that we hope to receive from owning shares goes to the ?first principles' of what shares are.  Investing in shares means that we become a part owner of a company.  That company earns some income, and each year a portion (on average about 60% to 70%) of that income is paid out to investors in the form of dividend.

The simplest analogy is to think of owning shares somewhat like owning an investment property.  Over the long term you hope/expect that the property goes up in value - however you also receive income from that property in the form of the rent that the tenant pays. Over time the rental income will tend to increase - just as over time the dividends paid by shares tend to increase.

This report looks at the reliability and quality of income paid by shares over long periods of time.  The results of the report are quite compelling and clearly show the benefit of owning shares as opposed to cash in terms of the income produced over the long term.

We have now uploaded this report on to our website and encourage you to take a look - The Benefit of Australian Share Income Over Time.

Regards,
Scott Keefer

Jim Parker, Regional Director of Dimensional Funds Australia (DFA) has posted his first Outside the Flags commentary for 2009.  The article looks at the performance of hedge funds in 2008.  In it he warns us of looking for an investment quick fix in response to the difficult year just passed.

Instead he recommends that you you might consider an alternative approach:

"one that makes no promises other than ensuring your portfolio gains reliable and efficient exposure to asset classes worldwide.

This approach recognises that markets are inherently unpredictable and that risk and return are related. Your best chance of harvesting the gains on offer is to remain disciplined in a diversified portfolio built around the known dimensions of risk.

To be sure, the premiums to be gained from taking on that risk are not always there, which is why they are called risk factors. But you are more likely to have a successful investment experience with this approach than you are by placing faith in those that promise you the world.

It's a New Year's resolution worth keeping."

I have included a copy of Jim's thoughts for your consideration:

A Resolution Worth Keeping

When the calendar turns over to a new year, we often find ourselves making pledges to ourselves?whether it be getting into shape, spending more time with our families or quitting all those things that aren't good for us.

Aware of this seasonal desire for renewal and reinvention, particularly after a year of such momentous volatility, a large part of the investment industry is busy marketing financial New Year resolutions.

For distraught investors looking for a fresh start, these slickly advertised promises to "armour-guard" portfolios, quarantine retirement savings and make money in down markets can seem awfully tempting.

But it's at these times that we need to remind ourselves that our search for investment quick fixes can leave us vulnerable to the persuasions of those who make promises they know they have no chance of keeping.

Just look at the performance of hedge funds in the past year. These highly speculative and complex investment vehicles promised to deliver positive returns in any market and charged very fat fees for doing so.

But rising correlations between asset classes this past year have combined with the magnifying effects of leverage to leave many hedge funds struggling to keep their promises and struggling to stay in business.

According to Hedge Fund Research¹, hedge fund liquidations were up by 70 per cent in the third quarter of 2008, with a record 344 funds closing. And this was before the impact of the scandal involving alleged Ponzi scheme operator Bernard Madoff, to whom some funds of hedge funds had a large exposure.²

As one analyst observed, the global financial crisis may merely have confirmed what many suspected: that the "alpha" that many hedge funds were charging all that money for was just "beta", or the ordinary market return.

Their promises of delivering positive returns by diversifying into illiquid and opaque alternative asset classes are looking a little tatty as well. Hedge funds delivered their worst-ever losses of just under 18 per cent in the 11 months through November, according to Hedge Fund Research.³

So what's the answer as your review your returns of 2008? Firstly, be wary of any marketer of an investment solution that promises to "beat" the market or puts your money at the mercy of their own forecasts.

Secondly, ask yourself whether you understand what you are investing in. It is difficult to judge your risk exposure and level of diversification when your fund refuses to disclose its activities beyond the most basic requirements.

Thirdly, even if the hedge fund managers really are highly skilled, consider who really reaps the rewards from their arcane activities. Is it you as the end investor or the managers themselves?

Lastly, before you make any rash decisions, you might consider an alternative approach?one that makes no promises other than ensuring your portfolio gains reliable and efficient exposure to asset classes worldwide.

This approach recognises that markets are inherently unpredictable and that risk and return are related. Your best chance of harvesting the gains on offer is to remain disciplined in a diversified portfolio built around the known dimensions of risk.

To be sure, the premiums to be gained from taking on that risk are not always there, which is why they are called risk factors. But you are more likely to have a successful investment experience with this approach than you are by placing faith in those that promise you the world.

It's a New Year's resolution worth keeping.

¹'Hedge Funds Face Bleak Future', The Sunday Telegraph, Dec 21, 2008

²'Broad Probe into Hedge Fund', The Wall Street Journal, Dec 26, 2008

³'Hedge Funds Return to Roots as Alpha Claim Refuted', Reuters, Dec 19, 2008

Welcome to our first blog entry for 2009.  I am looking forward to what I hope will be a much less gloomy year than that just passed.  (Sorry to be a touch cautious with my use of words here but much better this than having egg all over my face later)  For me personally the omens are good, January 25^th is the start of the year of the Ox according to the Chinese calendar.  I was born in the year of he Ox so I hope this makes 2009 a great year for me and more importantly for my clients!!

The first topic for the new calendar year I wanted to address was whether the start of a new year was a good time to reconsider your superannuation investment choice.  An article published in the Sydney Morning Herald on Saturday included data from a report compiled by Sweeney Research based on the responses of 1,000 super fund members aged over 45 years with balances over $50,000.  The data showed that 38% had changed asset allocations within their super funds last year, with 79% of those moving into more conservative options.  (i.e. 30% of those surveyed)

So if you have not already, should you be considering this same alternative?

Sounds like a simple question but the answer is far from simple.  As with most financial decisions, consideration needs to be had of your own personal situation.  This should include thinking through:

• Your goals leading up to full retirement, e.g.
• do you want to (and have the possibility to) work part time in the lead up?
• can you be making extra contributions into superannuation or are there other needs that need to be addressed first?
• The time until your planned retirement,
• generally speaking the longer the timeframe, the more suitable it is to be less conservative with your investment choice
• Your income needs in retirement,
• what income do you hope to be living off?
• The possibility of receiving Centrelink benefits in retirement
• Your expected life expectancy (or put another way, how long you need to be drawing an income from your superannuation assets)
• reaching retirement is not the end game
• Whether you have goals of passing on assets to younger generations or charity
• do you want a lump sum to be able to be passed on to your children or grandchildren or used to support charitable organisations?
• Your tolerance to volatility in investment markets
• how comfortable are you seeing your portfolio fall by 10%, 20%, 30%, 40%, 50%

Some suggest a further question to consider is what you (or your final advisor) think will happen to investment returns in the year, 3 years, 5 years etc ahead.  Our approach is that this is not a helpful question to be asking as there is no evidence that even the experts can predict or forecast what is going to happen in the near term.  If you wanted an insight into the empirical evidence behind this assertion please take a look at our Research Based Approach pages on our site.

Instead, a better question to ask is what the probabilities of different investment returns are over relevant timeframes given historical data.

Your answer to the investment choice question should therefore be dependant on all of these considerations and not your gut feeling about future market prospects.

If after careful consideration you think it is worth moving towards a more conservative investment allocation, the next step is to consider how best to achieve this.

The easiest way would be to simply sell down growth assets (shares & property trusts) or switch to a more conservative option (Balanced to Conservative or Growth to Balanced).  Unfortunately this involves selling these growth assets at what we might consider low prices and in doing so locking in the losses achieved through 2008.  If history is anything to go by, growth asset values should rebound.  It will not happen overnight but if history is anything to go by it should occur over time.

A better alternative might be to direct all future contributions and income payments from your investments into a cash alternative and by doing so build up a more conservative allocation over time without realising losses on those depressed growth assets.

If you wanted to discuss your options in more detail please do not hesitate to get in contact.  We offer a free, no obligations, initial consultation and are happy and keen to discuss alternatives.

Wishing you a great 2009.  Go the year of the Ox!!

Regards,

Scott Keefer

We have had a few weeks away from the office but are starting to wind up the springs for what will certainly be another "interesting" year for investment markets.  In preparation for a new year it is natural to be looking for those special tips to claw back some of those losses from 2008.  But be warned, forecasting is just another layer of risk for your portfolio.  For us, it is a layer of risk for which investors are not consistently rewarded for taking on.

Today's Australian newspaper provided further evidence of the risks involved with following forecasters.  It included a frank admission that the panel of 8 expert stock pickers they turned to at the end of 2007 have produced tips that underperformed the All Ordinaries index for the year - Stock pickers looking for new crystal balls.

The figures had the aggregate of the panelist recommendations providing declines of just over 50% while the All Ords index has fallen by 45%.  Not a huge difference, but for us every percentage point is important.

One point the article does not make is that investors would have been even better served by investing into developed world international markets.

It will be interesting to see the forecasts that are made for 2009.  As the article suggests in the opening paragraph, it might actually be better to listen to the advice and do the opposite.  Better still, why not employ an index based approach, diversify your portfolio across a range of asset classes - cash, fixed interest, Australian shares, international shares and listed property.  Please take a look at our Building Portfolios page for more details.

2008 has highlighted again that nobody really knows what is going to happen in the year ahead, a better strategy is to take away this forecasting risk from your portfolio.

In his latest article written for Alan Kohler's Eureka Report, Scott writes about the financial advice model employed by Storm Financial.  He specifically criticises the inappropriateness of this financial advice provided by Storm and the devastating impact for some clients.

Click on the following link to read Scott's thoughts - Storm's doomed model

In his latest article written for Alan Kohler's Eureka Report, Scott writes in conjunction with JamesThomson's piece - Investors caught in tropical Storm.

Scott specifically looks at the double gearing strategy reportedly used by Storm.

Click on the following link to read Scott's thoughts - A fatally flawed model

Glancing through the financial media this morning I came across a very interesting article on the Wall Street Journal website - The Stock Picker's Defeat.  The article looks at the terrible year for the Legg Mason Value Trust in the USA.  The fund manager is William H. Miller who is dubbed in the article as the era's greatest mutual fund manager.  This has been bestowed on him because every year from 1991 to 2005, his value trust outperformed the broad S&P 500 Index in the USA.

Unfortunately 2008 has been a devastating year for the trust and its investors.  According to Morningstar, investors have lost 58% of their money over the past year, 20 percentage points worse than the declines of the S&P 500 Index.  Some might think that this is not so bad given the outperformance over 15 years up to 2005.  Unfortunately that outperformance has now been wiped away.  A graph included with the article clearly depicts this and Morningstar now has the fund amongst the worst performing in its class for the last one, three, five and ten year periods.

This is another example of the dangers of an active manager style approach to investing.  Fund managers do have periods of outperformance.  This may be through some skill on the part of the manager or more likely just the function of probability and chance.

Even if there is such a thing as skill on the part of fund managers, another problem faced by investors is the ability to find such a manager that is going to out perform in the long run going forward.  This article suggests that investors who have come to the Legg Mason Value Trust party later in the course of events most likely have under performed the index return.

This index return, over the long run, is what we refer to as the return investors deserve to be getting from investing in the share market.  Putting it at risk by following an active style manager is a risk we believe is not rewarded over the long term.

On our website we have developed pages and a downloadable document which outlines our Research Based Approach to investing.  One section of that material includes research that has been conducted which finds no evidence that choosing a managed fund that had outperformed in the past would provide above average returns into the future.

If you are interested in finding out more about our approach and the research which underpins it please take a look at our Building Portfolios and Research Based Approach pages of our website.

Regards,

Scott Keefer

The latest edition of our fortnightly email newsletter was sent to subscribers Wednesday 10th December. 

If you would like to be added to the mailing list please click the following link to be taken to the sign up page - The Financial Fortnight That Was Sign Up Page.

The following is the market news section for the latest newsletter:

ASX P/E Ratio and Dividend Yields

An interesting article was published in today's sport section of the Courier Mail.  It outlined the results from the Brisbane Lions (AFL club) AGM.  (I must be totally up front from the outset that I am an avid Carlton Blues fan and therefore could be seen to have a bias against the Lions.  However, as long as they are not playing Carlton I am a Brisbane supporter.)

The interesting part of the article for us financial boffins was the devastation in value of the club's equity portfolio.  It had fallen from a value of $5,026,093 at the 31st of October 2007 to a current value of approximately $2,006,911.  This equates to a fall of 60%.  The article reported that the portfolio was made up of Australian shares.

To put this in perspective, the ASX200 accumulation index had declined 40% decline over that period.  The ASX200 Listed Property sector fell 55%.  The MSCI World Index (ex Australia), a measure of the rest of the international share markets apart from Australia, saw a decline of 23.2% over the same period in Australian dollar terms.

This data shows up two key concerns with the Brisbane Lions approach:

• Active Management
• Lack of diversification

The active management approach that has been followed by the Brisbane Lions has come up well short compared to the less glitzy but much more dependable index style approach.  No one likes to see negative returns in their portfolio but if you are going to have negative returns I would much prefer a 40% decline compared to a 60% decline.

The past year has also shown up the concern of holding an undiversified portfolio of investments.  The Australian share market over the past 5 years to the end of 2007 had provided significantly better returns compared to international markets.  Thanks predominatly to the fall in the Aussie dollar exchange rate some of those gains have been reversed and it has been much better to be invested in international investments over the past 12 months.  Holding a diversified portfolio including Australian shares, international shares and listed property in our opinion serves clients much better in the long term.

In the long run we would expect that Australian shares, international shares and listed property to provide very similar returns for investors.   Holding this kind of a diversified portfolio therefore smooths out portfolio returns over time while still providing a similar or even better return than holding an individual asset class.  This smoothing effect is much more palatable for investors.  If you hold an index style approach you add even further diversification in your portfolio.

I love watching the Brisbane Lions play but I for one won't be following their investment approach!

Regards,
Scott Keefer