I am pleased to announce that the Monday's Money Minute podcasts are back for 2009.  I look forward to sharing insights with listeners over the coming year relating to financial planning and investment strategy.

The first topic for the year relates to the proposed changes to the income test used to assess eligibility for a range of government offsets and benefits.

These changes will have some significant impacts for those using salary sacrifice strategies and also those who may be accessing the Commonwealth Seniors Health Card.  For more information please listen to the podcast - Watch out for the new federal government income tests.

From July 1, 2009, the federal government is planning to put in place changes to the income test applicable to a range of government assistance programs.  These changes may be quite significant depending on your circumstances.

The changes will see the following included in certain income tests:

• Voluntary salary sacrifice superannuation contributions.
• Net financial investment losses (negative gearing deductions).
• Adjusted fringe benefits.

Under these proposed changes these amounts will be included in the income test for the:

• Government superannuation co-contribution.
• Pensioner and senior Australians tax offset.
• Mature age worker tax offset.
• Spouse superannuation contributions tax offset.
• Baby bonus.
• Childcare benefit.
• Child support.
• Family tax benefit (FTB) parts A & B

In particular, those using salary sacrifice contributions to provide greater access to these offsets and benefits, may have to revisit this strategy in light of the changes.

Information from the government also suggests that all income stream and lump sum payments from a taxed super fund would be counted as income for the purpose of assessing eligibility for the Commonwealth Seniors Health Card (CSHC) - whether or not the benefit comprises a tax-free component or is otherwise non-assessable.

This would mean that those of age pension age who are accessing their superannuation assets to draw a tax free income stream will be affected by this change.  Under current laws, this tax free income stream is not included as part of assessable income for the CSHC income test.  Those who use a transition to retirement income stream strategy will be hit twice as from the 1st of July not only will the pension stream be assessed but so will voluntary salary sacrifice contributions into superannuation.

Including the tax free income stream as assessable income along with voluntary salary sacrifice contributions may well tip some self funded retirees, or those who continue to work passed age pension age, over the cut-off threshold and cause them to be ineligible for the CSHC.

If you wanted more information on the proposed changes please refer to the consultation paper found on the Federal Government's Treasury website - http://www.treasury.gov.au/contentitem.asp?NavId=037&ContentID=1438 and the Commonwealth Seniors Health Care Fact Sheet found on the government's Department of Families, Housing, Community Services and Indigenous Affairs website - http://www.facsia.gov.au/internet/facsinternet.nsf/seniors/cshc_changes.htm

Regards,
Scott Keefer

Unfortunately investment fraud is most certainly a risk for investors to consider when setting up and maintaining investment portfolios.  The Madoff affair in the USA has caused waves throughout the world.  In Australia, some might say that even though the Storm Financial saga was not about fraud, misleading behaviour might have been at play. (This looks set to be tested in the courts.)  So how do investors protect themselves from getting caught out by fraud or misleading behaviour?

I am a candidate in the Chartered Financial Analyst (CFA) program.  As part of this I get access to some very useful resources that I hope to share with my clients and users of this website.  One of the latest publications from the CFA Institute looks at 10 tips on avoiding investment fraud and this was written in response to the Bernard Madoff Hedge fund Ponzi scheme in the USA. (for the original article - http://www.cfainstitute.org/aboutus/press/release/09releases/20090121_01.html)

Here are the 10 tips and a response to how our approach rates on each tip:

1.      Understand clearly the investment strategy - our philosophy and the philosophy of the fund managers we favour is clearly set out and publicly available - www.acleardirection.com.au/building_portfolios, www.dfaau.com, www.vanguard.com.au, www.ssga.com/australia.

2.       Match investment strategy to reported performance - The old saying rings true, "if it sounds too good to be true it probably is".  The index based approach we use to build client portfolios is transparent.  For example, if you hold an ASX200 Index Fund you know pretty much exactly the underlying companies you are invested in and returns should be very similar to the widely reported returns of the ASX200.

3.      Watch for e-mail solicitations and Internet fraud - our firm nor the fund managers we favour do not send out unsolicited communication.

4.       Be wary of "sure things," quick returns, and special access - Our philosophy is anything but these things.  The only "sure thing" we are offering clients is that their returns will be very close to index returns less a small amount for fees with some upside from investing in the small, value and emerging markets areas within asset allocations.

5.       Understand what, if any, regulatory oversight exists - In Australia, financial advisers and managed funds are regulated by ASIC or APRA (for superannuation funds).  We have not yet seen the failure of a managed investment scheme through fraud in Australia.  All the funds we use have annual reports publicly available on their websites along with external audit reports.

6.      Assess the operational risk and infrastructure - It is important that an investment firm has separate, independent operations for asset management, trading, and custody to provide checks and balances against fraud.  The funds we utilise have these checks and balances.

7.       Ask about independent audits and who performs them - the three fund managers we use for client portfolios have their annual reports along with audit reports publicly available on their websites.

8.       Assess the personnel - Our credentials are clearly set out on this website.  In terms of the fund managers we suggest, the index approach to investing takes a lot of this risk off the table because you as an investor are now investing in the whole of the market not just a couple of companies.  Dimensional (DFA) add a few more touches to their investments through incorporation of the 3 factor model and investments in emerging markets.  They clearly set out the personnel on their investment committees in their PDS and on their website and also highlight the links back to the world renowned scholars, including Nobel prize winners for economics on who's research they base their approach to investing.

9.       Perform a background check - you are able to perform a check of my authorised representative status along with the financial services license of the fund managers we suggest clients use at www.asic.gov.au

10. Limit your exposure - Our approach is that we suggest clients hold a really well diversified portfolio in terms of what they are invested in.  This is a key reason why index style investing works.

On point 10, some ask the question - is it safe to have a large part of our investments with one fund manager such as Dimensional?

Our response is that in Australia, given the strong regulation by ASIC along with the structure of the investment trusts through using trustees and further supported by the transparent nature of the investments i.e. index style funds where you have a really good understanding of what the underlying investments, we are really confident that the need to diversify between fund managers is small.

Of course, these tips cannot guarantee that you will avoid investment fraud but they will increase the likelihood that you will make smart choices. Also, by asking the right questions and arming yourself with relevant information, you become one of the informed investors who are more difficult prey for scam artists.

Regards,
Scott Keefer

About CFA Institute

CFA Institute is the global association for investment professionals. It administers the CFA and CIPM curriculum and exam programs worldwide; publishes research; conducts professional development programs; and sets voluntary, ethics-based professional and performance-reporting standards for the investment industry. CFA Institute has 100,000 members, who include the world's 86,700 CFA charterholders, in 133 countries and territories, as well as 136 affiliated professional societies in 57 countries and territories. More information may be found at www.cfainstitute.org.

The Access Economics report published yesterday paints a reasonably bleak picture of what's in store for the economy in 2009.  However, not all commentators / analysts / experts have come to the same conclusion.

An expert I like to keep an eye on is Jeremy Siegel, a Professor of Finance at the Wharton School of the University of Pennsylvania.  He is also well known for his research into long-term stock and bond returns, as published in his best selling book Stocks for the Long Run.  A profile of Professor Siegel can be found at Yahoo Finance.

Professor Siegel writes a regular commentary piece for Yahoo Finance.  His latest piece - 2009: A Much Better Year - provides quite an optmistic outlook for the year ahead.  He, like other commentators, is hesitant about making an outright prediction as he has been badly burnt by previous attempts, but his suggestion about 20% or higher returns for the year is something to contemplate.

Do we believe that his forecast will be correct?

It is difficult to say.  What we do know is that there are a range of viewpoints about the year ahead.  Some absolute doomsday predictions while others in present conditions seem overly optimistic.  For me this suggests that nobody really knows for sure.  The best strategy therefore is to keep to your long term plan. Don't go selling out of growth asset positions.  If you can afford to be buying regularly over time through dollar cost averaging or value averaging over the next few years then this is well worth consideration to protect against buying today and seeing the market fall further over future days and months.

Regards,
Scott Keefer

Saturday's Courier Mail included a piece on the collapse of Storm Financial and the impact on their clients - Storm Financial's name a clue to what lay ahead.  Scott Francis was quoted a number of times in the article:

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Financial planner Scott Francis said the Storm plan of borrowing huge sums to invest in index funds relied on an ever-rising stock market.

Now that global markets have tanked, around 3000 of the company's clients have been left exposed.

About 10 per cent of these clients owe more than the value of their portfolios and are $20 million in the hole.

Mr Francis said that the company employed a "one-size-fits-all" strategy for investment, so that young workers and those nearing retirement would have the same plan regardless of their circumstances or goals.

"Investors sought advice on their financial situation and Storm Financial advised them to borrow heavily," Mr Francis said.

"It appears that it didn't seem to matter if they were retired, close to retirement or had little income.

"The answer was the same: get your hands on some debt, gear it up further using an aggressive margin loan facility and then wait for the share market to work its magic.

"What's wrong here?

"It's not the products, it's not even the structure of the investment.

"The problem is bad advice ... It seems to me that there was no way the average Storm Financial investor would be able to navigate a steep share market downturn."

Adding to the misery, Mr Francis criticised Storm for charging excessive entry fees of up to 6.6 per cent and then 1.14 per cent annually.

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Please click on the following link to be taken to a copy of the article - Storm Financial's name a clue to what lay ahead.

In his latest article written for Alan Kohler's Eureka Report, Scott looks at the fund of funds structure.  He highlights the high cost concern with these style of funds providing an example of one fund with the following levels of fees:

1. The brokerage fees when underlying shares are bought or sold (paid to the stockbroker).
2. The fees of the actual fund managers.
3. The fees charged by BT to act as the "multi manager".
4. The fees of the independent investment consultant.
5. The fees to the custodians who hold the actual assets for investors.
6. The commission to the financial adviser (the Product Disclosure Statement says it is an ongoing commission of up to 0.6%).

Click on the following link to read Scott's thoughts - Funds structure in big trouble

This was the headline of an article posted on the Wall Street Journal website on the 4th of January.  The article posed this question:

During a market comeback, is it best to be invested in actively managed funds that aim to beat their benchmarks? Or is it better to stick to index funds that simply rise with the tides?

The article provided insights from a range of US analysts.  Click on the following link to be taken to the article - Active or Index Funds for '09?

Lets start with the argument against indexing.

Some investors argue that by investing in a fund that mirrors an index you are holding not only the fastest-rising sectors but also the laggards. An active manager may be able to avoid the low performers and use cash to nimbly pick up shares of companies that are growing ahead of the market.

Unfortunately the evidence is against this theory.  Take a look at our Active Fund Managers Underperform page on our website.

Unfortunately the evidence presented in the paper suggests that such an approach is risky because in the recoveries from the past three bear markets, index funds have come out ahead of managed funds on average, according to data from researchers Lipper Inc. and Morningstar. 

Over the 12-month period following the most recent bear market in the USA that ended in March 2002, less than 30% of actively managed funds beat their benchmarks, according to Morningstar.

Another interesting statistic included in the article was that "actively managed funds certainly didn't shine versus index funds last year, with some 58% of actively managed U.S. stock funds failing to beat their benchmark indexes in 2008, according to Morningstar."

Our approach at A Clear Direction is that we firstly do not know whether there will be a rebound in markets in 2009.  We certaintly hope so but we (along with all other commentators and experts) have no skill or ability to make this prediction.  Rather, we continue to build investment portfolios for clients taking into account the risk that markets may fall further but also based on the historical data that shows that market will rebound some time in the future as they have done so in the past.

We do this not by picking active managers or trying to time entry into and out of the market but by using index funds based using the 3 factor model of how markets work.  If you wanted to know more about this approach please take a look at our Building Portfolios and Research Based Approach  pages on our website.

My answer then to the initial question - Index funds for 2009 and beyond!!

Regards,
Scott Keefer

Our Building Portfolios page sets out philosophy towards building investment portfolios for clients.  At the core of this philosophy is the 3 Factor model.

Academic researchers in the USA have identified two sources of additional return beyond just the average market return (the index return).  This research was conducted and published in the early 1990's by University of Chicago Professors Eugene Fama and Kenneth French, and their results are known as the ?3 Factor Model' of investing.  Importantly, Fama and French's research has been consistently repeated in markets around the world and shows that two factors - company size and value (or company health) are sources of above market average returns.

·        The Company Size effect identified that small company shares have higher expected returns than large company shares.  This is not entirely new to Fama and French's research, it had been proposed for some time.  An example of a small company would be the Bank of Queensland - much smaller than the Commonwealth Bank which is amongst the 5 biggest companies listed on the Australian stock exchange.

·        The Value Effect identifies that financially pressured or out of favour ?value' companies have higher expected returns than healthy and popular companies.  This does not seem to make sense at first glance.  One way to think about it is this, when a company is out of favour or under financial pressure everyone sells their shares.  The price of the company falls, and it is only once it has fallen a long way that people become interested in buying it again - only once they are attracted to the company by the higher expected returns that come about because its share price has fallen so far.

These same professors who developed this model have been sponsored by Dimensional to create an online forum.  The website offers a venue for them to share their ideas and perspectives with Dimensional investors, affiliated professionals, and the general public. The professors will use the forum to comment on financial topics, highlight current research, answer frequently asked questions, and point viewers to information sources they find engaging.

I really encourage you to take a look at this new website by clicking on the following link - Fama/French Forum and also to keep track of the ongoing discussions that occur there by subscribing to the RSS feed.

Regards,

Scott Keefer