2009 has been a tumultous year for the global economy and more specifically investment markets.  Interest in our approach to financial and investment planning has driven strong growth for the business with a side effect being a less than consistent delivery of our email newsletter.  In order to rectify this situation we will be reducing the number of newsletters published to one per month.

A consequence of this decision is that the name of our newsletter needs to change.  For the time being the newsletter will be titled Clear Directions.

The latest edition of the newlstter has been sent to subscribers this afternoon.

In this edition we look at one particular area of interest at present - the strength of the Aussie dollar.  We look at this issue by looking at Currency Hedging.

Also in this edition we:

• provide updated market return data in our market news section,
• consider the use of debt recycling,
• provide a link to Scott Francis' latest Eureka Report articles,
• outline changes to the definition of income in relation to government payments income tests,
• link to Vanguard's updated Index Chart and their latest series of video pieces, and
• provide evidence of the three factor model in action.

Please click on the following link to be taken to A Clear Direction's Email Newsletter Archive.

Enjoy the read!!

I have just finished watching the new documentary series on the ABC - Addicted to Money.  For those interested in all things financial it was well worth watching.  The following is a synopsis of the program on the ABC website:

Addicted To Money is THE program for anyone who wants to know how the financial crisis came about, what it means for us now, and what we can do to create a sustainable economy. Biting and punchy, this three-part series is a survival guide for the ?New Economy', presented with wit, charm and incisive appeal by David McWilliams, a young economist who talks just as candidly to the most influential and powerful players in the global economy as he does to ordinary people.

In the first episode of this polemical series, David McWilliams establishes that we have not just been living through a global recession, but what amounts to a coordinated economic crime. The banks were not only in control, but also out of control. The financial industry established what was effectively a drug syndicate, pushing the most dangerous addiction of all, easy credit. "When even the suburban bank manager has become a drug pusher, things are seriously unhinged," says McWilliams.


For next week's episode:

In episode two of Addicted To Money David McWilliams reveals how Australia and many other nations have become ?one-trick' economies, vulnerable to the inevitable sudden shocks that are a by-product of a fragile, globalised economy.

In Australia's case, we have become totally dependent on Chinese resource demand, putting our future in the hands of "a party-state dictatorship with a very big cheque book" says McWilliams.

China in turn has marched itself up an economic cul-de-sac, becoming overwhelmingly dependent on demand for its exports and in the process accumulating masses of potentially volatile US dollars.

McWilliams predicts that the US is headed for de facto default of its sovereign debt, and this has consequences for all of us.

Keep an eye on the ABC's webpage for further updates - http://www.abc.net.au/tv/guide/netw/200911/programs/DO0838W001D2009-11-05T203500.htm

Regards,
Scott Keefer

Scott's latest article in the Eureka Report looks at how listening to three key pieces of advice from Warren Buffett would have helped investors over the past year:

For those investors who are open to using debt in their situation to build wealth the implementation of a debt recycling strategy may be of value.

A Debt recycling strategy is where home owners with a mortgage transfer debt from the non tax deductible home loan to a tax deductible investment loan through the course of paying down the home loan.

The benefit of the strategy is that interest payments on the investment loan are able to be deducted from investment income when it comes to income tax time each year.  In essence, by doing this you are seeking the assistance of the federal government to help build your pool of financial assets.

Is it a good idea for everyone?

Definitely not.  The first key step is to undertake a stress test of your current debt position.  In its simplest form this means looking at the impact on your your cash flow should interest rates rise.  Will you still be able to make loan repayments if interest rates rise to certain levels.  This is very pertinent at the moment as more and more commentary suggests that the Reserve Bank will lift interest rates by 2% over the course of the next 12 to 18 months.  i actually think you should stress test your situation in case rates rise by 3 or 4% to be even more comfortable that you are not holding too much debt.  See the problem becomes that should interest rates rise to levels where you are unable to make loan repayments you will most likely be forced to sell.  If interest rates have risen by significant amounts there is a good chance that this will be exactly the time you do not want to sell.

(To add another layer of complexity, it is also worth contemplating what would be the situation if you lost income for whatever reason for a period of time - cut back in hours, ill health, retrenchment - how long could you continue to make repayments on a particular loan value - but lets leave this for another blog.)

Once you have gone through this exercise and decided that you could afford to maintain $X amount of debt even if interest rates rose to a level well above say 10%, you could possibly be looking at a strategy of once paying down so that you home loan is now less than $X every extra dollar you pay off the loan is used to increase an investment loan which is used to invest in other growth assets like shares and listed property.

Is it a good time to invest in shares and listed property?

The next question that should be asked is whether now is a good time to loan money to invest in shares.  With interest rates at between 5 & 6% the odds are in your favour because over the long term shares have provided a return of between 6 & 7% above inflation.  So if the Reserve Bank is targetting inflation of 2 to 3% this suggests that shares should provide a return of 8 to 10% over the long term.  Wo this comparison looks pretty positive.  However as interest rates start to rise in the economy the differential between the cost of the loan and the likely return from the investments starts to narrow and the likelihood of success also narrows.

Now in the interests of providing a full and frank viewpoint, some will suggest that maybe the risk premium for investing in shares is higher than historical levels.  This is saying that the current risks involved with investing in shares, which we have been all clearly reminded off through 2008 and early 2009, may be more than usual and therefore investors expect a higher return than the 6 or 7% premium above inflation.  The period March to September 2009 would suggest this has been the case but we can not be certain that such conditions will continue going forward.

On the opposing side are those that suggest that the world economy is in the middle of an L or W shaped cycle where there is at best a long period of little growth ahead of us or at worst we are in a bear market rally with bad conditions still to be faced.

What do I think?

I claim no ability to predict the future so for me it comes down to this question -

Do you need to take on extra risks to reach your financial goals or are there other strategies at your disposal through cost reductions and the like?

If you don't need to use debt than don't.  If you do, then seriously weigh up the possible outcomes and limit the use of debt to the minimum.

As always the decision comes down to each person's individual circumstances.  If you are thinking of using this strategy it would be very wise to first consult a financial adviser for guidance.

Following up from my previous blog - MLC have a useful case study on their website which explains the strategy of debt recycling.  It is worth a look for those who might be contemplating this approach - MLC Debt Recycling page.

Regards,
Scott

Regular readers of this blog and website will know that we are not big fans of the big financial institutions when it comes to the costs involved with using their services or approaches to investment.  However they do produce some useful advice for consumers which is especially helpful when you don't have to pay anything for it.

Today I have come across some pages on MLC's (owned by the National Australia Bank) website.  The pages look at the following strategies to pay off debt sooner:

- consolidating debts into the lowest cost option (eg credit cards and personal loans consolidated into the homeloan)
- using emergency cash reserves most effectively - most of us want cash stored away for a rainy day.  Using an offset accpount or redraw facility makes good sense for this purpose.
- making the most of your cash flow through increasing the frequency of payments, reducing living expenses, depositing your entire salary into the loan account, using a credit card to pay most of your expenditure but making sure this is paid off in full each month.

For those in this stage of your life it is well worth taking a look at MLC's website for more details - Pay off your home loan sooner

Regards,
Scott Keefer

Each day we read, listen to or view commentators who put their spin on the latest happennings on financial markets.  For those who are keenly interested this commentary can be at times informative and at times even quite amusing as commentators try to explain what has happened and what is likely to happen going forward.

Jim Park from Dimensional Fund Advisors has put his own slant on this issue in his latest posting on Dimensional's website.  He reminds us to be careful paying too much attention to the noise being generated by the financial media.

Following is a full copy of Jim's piece:

From Cacophony to Symphony

Sometimes it's hard to make sense of day-to-day noise in stock prices, particularly when news is thin on the ground. But that doesn't stop lots of people from trying to discern predictable patterns in the racket.

Building coherent narratives out of random stock price moves, often under the pressure of constant deadlines is the job of journalists and research analysts. The most successful ones make it all seem perfectly rational and predictable.

This ability to communicate the idea that 'this happened in the market because that happened' is most brilliantly demonstrated when circumstances change two or three times in the space of a day or two.

Let's take a look at a recent example. In the week beginning October 5, the media reported that markets were anxiously awaiting a policy meeting that week of the Reserve Bank of Australia's board.

While there was disagreement about the timing of the move (most thought it would come in November), there was a strong feeling that the RBA was on the brink of raising interest rates, becoming the first 'Group of 20' central bank to do so in the wake of the global financial crisis.

On the Monday ahead of the RBA meeting, the Australian share market fell by 0.6 per cent. One journalist quoted dealers as saying there was a fear that an early rate hike could shake market confidence and curb the recovery.¹

Sure enough, newspapers on the morning of the bank's meeting were full of dire warnings of what would happen to asset markets if the Australian central bank broke from the pack and started to withdraw stimulus too early.²

As it turned out, the RBA did raise its cash rate that day, by a quarter of a percentage point to 3.25 per cent, and a month earlier than most expected.

And what did the Australian market do? It closed higher. The benchmark S&P/ASX 200 index ended up 0.4 per cent, albeit off its intraday peak. According to an analyst quoted by Dow Jones, the rate rise could actually be seen as confirmation of the strength and resilience of the Aussie economy.

But the story didn't end there. Not only did the RBA's "surprise" rate move fail to derail the Australian market, it actually triggered a global rally. The Wall Street Journal: "A surprise interest rate increase in Australia reignited confidence that the global economy is recovering from recession, sparking stock market rallies around the world and lifting gold prices to record highs."³

You see how these rolling interpretations work? You keep changing the narrative to suit the changing circumstances. The trick is to make it all seem perfectly obvious after the fact. "This happened because that happened."

The fact is stock prices move for all sorts of reasons, and trying to provide neat and immediate explanations is a treacherous business for young players. Sometimes a price changes because of news related to the individual stock. But even then, just as with economic news, the reaction is not always what the media say it will be, usually because the market has already priced it in and is looking one step ahead.

Back in mid-September, the Australian government created a stir when it announced that it would force the nation's largest phone company, Telstra, to split into separate wholesale and retail businesses.

On the day of the announcement, Telstra shares slid more than 5 per cent. The government's break-up order, according to one wire service report⁴, represented a "giant kick in the teeth" for the company's shareholders.

The next day, though, the story changed. Telstra shares regained all of their losses. Analysts had now reviewed the break-up plan and decided it would help position Telstra to secure part of a lucrative national broadband deal.⁵

So the narrative of why stock prices rise and fall on any day changes because new information is always coming into the market. No sooner has the journalist carefully crafted a water-tight story out of one development, than something else happens and the whole edifice springs a leak.

Stocks often move because of investors' views of equities as an asset class, not for any reason related to the individual stock. The market may move higher or lower and individual stocks will shift up and down by a certain amount in sympathy, depending on how sensitive they are to market risk.

Stock prices also can move for apparently no reason at all, or at least for no reason that the media takes notice of. It could be because a large institution is liquidating a portfolio or because of arbitrage activity between the physical and futures market or because of options expiries. It may just be because someone is selling a large parcel of one stock to fund a purchase of something else. None of this is particularly interesting or significant in the big scheme of things. It's like watching rush-hour traffic.

The bad news for harried journalists and market analysts is that they have to try and orchestrate all the random noise that constitutes messy day-to-day reality into a fascinating, elegant and seemingly pre-ordained symphony. And every day, they have to start all over again.

The good news for the rest of us is that there is no compunction to listen.

¹'Australian shares fall 0.6%, banks skid on rate talk', Reuters, Oct 5, 2009

²'Housing disaster looms if rates rise', The Australian, Oct 5, 2009

³'Australian rate rise spurs stock, commodity rallies,' The Wall Street Journal, Oct 7, 2009

⁴'Shareholders say not one good thing in Telstra proposal', Australian Associated Press, Sept 15, 2009

⁵'Australian shares up 2.4%, banks surge', Reuters, Sept 16, 2009

The issue that tends to get the most air time and newspaper coverage in highlighting all that is wrong with the financial planning industry is the issue of trailing commissions.  This is the pratise whereby advisrs are paid a fee from product providers for recommending a client invest in that product.  The perceived problem with this is the accusation that can be alleged that a planner is recommending a product based on the amount of commission they are receiving not because it is in the best interests of the client.

I agree that this is a practice that needs to be looked at.  However an even larger issue for me is that of ownership bias.  This is where planners, because they are owned by a large financial services company tend to recommend that company's investment products.  I think the same allegation of whether this recommendation is in the best interest of the client can be levelled at a planner.  At least with trailling commissions, planners can recommend what they think is the best outcome for client.

Of course, combining the two is probably the worst of all outcomes.

An article published in the Herald over the weekend provides some interesting data on this issue - Finance advisers mostly a sales force, report says.

"In the year to June, for example, 80 per cent of sales by financial planners at Westpac and its subsidiary BT went to funds owned by the bank. The in-house sales figure was up from 72 per cent a year earlier.

For financial planners working for money managers AXA and AMP, 82 per cent of their sales return to their parent company. Colonial and the Commonwealth Bank retain about 72 per cent of the sales of their financial advisers.

The study was based on figures from July 2005 to June 2009 from almost 6000 superannuation products obtained from the six leading planning groups."

Now it might well be that the investments offered by these planners are in the best interests of the client.  Unfortunately there is such a level of perceived conflicts of interest for investors that theis assertion would be seriously doubtful.

The research based approach used by A Clear Direction suggests that the type of funds recommended by the big financial institutions tend to be actively managed, higher fee offerings which over time tend to provide below average performance.

In conclusion, take care when using the services of the big financial services industry that the advice being offered is in your interests not in the interests of the controlling company.

Regards,
Scott Keefer

MENSA is the group for individuals with IQ's in the top 2% of the population.  They have an investment club, and Eleanor Laise looked at this investment club in an article entitled ?If we are so Smart, Why Aren't We Aren't Rich?'.  

Over the period 1986 to 2001 the Mensa investment club managed a return of 2.5% a year.  The average market return for this period was 15.3% a year. 

From the MENSA club chair: "it was my hope that a special-interest group within MENSA would have the intellect that would give us some kind of advantage."

What, then, explains the disparity between club members' formidable IQs and derisory results? Laise provides a strong hint: during the past 15 years its chairman-editor has also been "a committed chartist and incorrigible techie [who] has transformed the club, which has $70,000 in assets, from a small-cap, value-oriented group to a highflying, momentum-buying Nasdaq nightmare. The centrepiece of his strategy is the TC 2000, a technical charting program that seems like a prop from the set of Star Trek. [According to the chairman-editor], ?this program is the coolest thing. You can show various types of graphs and add indicators, like linear regression, moving average, Bollinger bands. Then there's volume, stochastics, MACD, time-segmented volume, stuff like that. You can add all kinds of indicators and really confuse yourself.'"

It is an interesting story - and interesting to see the ?smartest guys in the room' with the best software support struggling to generate a reasonable rate of return.

As Warren Buffett - one of the world's great investors - has said, "Investing is not a game where the guy with the 160 IQ beats the guy with 130 IQ..What's needed is a sound intellectual framework for making decisions and the ability to keep emotions from  corroding that framework."

Scott's latest article in the Eureka Report looks at the prickly issue of executive remuneration packages.  Removing ourselves from the debate around fairness, Scott cuts to the heart of the issue for investors - What is the impact on share price?

In his article Scott conducts analysis on 3 household company names - Commonwealth Bank. Telstra and Qantas to look at the impact of reducing executive pay levels.  He concludes:

"The calculations for Qantas, Commonwealth Bank and Telstra show that big salary packages to affect earnings and share prices, but not to a great level. Indeed, if a highly skilled executive were able to increase shareholder return by 1% a year, they would justify the paying of a high salary.

The more interesting story is that of the Productivity Commission recommendations and its recommendations to give shareholders more power to vote on executive remuneration, recommendations supported by the shareholders' association.

Moves away from continued salary increases well in excess of inflation, to genuinely involving shareholders (company owners) in the remuneration process, would seem to be a step in a positive direction."

Please click on the following link to be taken to the article - Why executive pay doesn't matter (to shareholders).

In a recent article published by Scott Francis in Alan Kohler's Eureka Report, Scott looks at the strategies that can be implemented by those close to retirement and suggests some relatively minor changes can lead to a significant improvement in outcomes achieved.

Scott identifies four factors that will reward those who stay or go back to work:

• The chance to invest while investment markets are depressed.
• The chance to put in place a (very) tax-effective transition to retirement income strategy.
• The chance to deliberately use your superannuation contributions to position your retirement portfolio.
• The fact that the longer you work, the shorter the period that you rely solely on your investment assets to fund your retirement, and the more likely they are to meet your needs

For those of you at that period of your life or who have family or friends who are, I encourage you to read the article - Winning in the retirement risk zone.