Tuesday, October 31 2006
The key partner that we use in building investment portfolios is Dimensional Fund Advisors. We use them because their investment solutions are grounded in the reality of how investment markets function. And their investment solutions work.
They focus on applying the latest in academic research to building investment portfolios. This includes the '3 factor model', which identifies that small companies and value companies are sources of higher expected returns.
Over the 5 years to the end of October 2006, the returns of the Australian Dimensional Fund Advisor trusts has been:
Large Company Fund (which is very similar to the ASX100 index) 15.35% a year. Keep in mind that very few funds ever beat this index return.
Value Company Fund (which invests in the 30% of the market with 'value characteristics') 21.53% a year.
Small Company Fund (which invests in companies outside of the ASX100) 21.18% a year.
These are truly impressive returns. They don't come from the 'skill' (or 'luck') that most fund managers profess to have in being able to pick stocks that will perform better in the future - they come from studying the reality of how investment markets work, and investing accordingly.
Moreover, the Dimensional approach focusses on tax effeciency, so the after tax returns of the funds remain strong. This contrasts with most managed funds where there is significant underlying trading that means a lot of capital gains tax is passed on to investors over time.
Dimensional Fund Advisors have recently produced a brochure entitled 'The Science of Investing' that explains their philosophy. It is well worth a look.
Tuesday, October 31 2006
In this article in the Sydney Morning Herald, published on Saturday, the following quote was attributed to the IFSA (Investment and Financial Services Association):
'Commissions allow people to access advice and pay for it over time via their savings," IFSA says. "Commissions also tie the interest of the consumer and the financial planner, and give an incentive for the planner to maximise a consumer's savings'
I simply can't stand to see such a ridiculous comment go unchallenged. In my opinion commissions do exactly the opposite. For starters, a financial planner who relies on a commission model will only recommend financial products paying a commission. Secondly, the size of a commission is capable of distorting the advice given by a financial planner - just look at the Westpoint Collapse where financial advisors were accepting high commissions to put their clients into ridculously high risk investment 'products'.
More than anything, commission payments make financial planning a sales game. I don't believe this aligns the interest of financial planners and consumers at all. Indeed, consumers go to a financial planner looking for advice, not to be sold to.
Every other profession charges for its time on the basis of a fee - this is the model of what a profession is. Any suggestion that taking an ongoing trailling commission from a product recommendations is a more professional fee structure is, in my opinion, rubbish.
Thursday, October 26 2006
This transcript of an ABC radio interview provided some recent, and grave, statistics about the level of household debt in Australia.
Debt topped the $1 trillion mark. Assuming that there are about 10 million people working, that equates to about $100,000 for every working Australian.
With a rate rise on the first Wednesday in November looking increasingly likely, the pressure will be felt by consumers.
Yesterday I walked past a car advertising a lending business. It's slogan was 'We Lend Against Anything!'. In my opinion, that's not an exciting promise to consumers, that's a threat.
At the start of the year there were some people predicting that the next interest rate movement would be down. We have had two rises, with the strong possibility of a third. What does this mean for thoughtful investors?
1. Always be sure that there is room in your budget to increase interest repayments if interest rates rise
2. Consider using a fixed rate mortgage. Sure, you won't be happy if rates fall, however you have certainty that you will be able to meet your repayments if rates rise.
3. Be like a business in that using some borrowed money is good, however you don't want to use so much that there is any chance that you end up with some financial distress.
4. Focus on paying debt down to a reasonable level quickly.
Tuesday, October 24 2006
There has been much talk over the past 24 hours about the very low level of superannuation that most Australians have. An ABC article here is an example of this.
The crux of the stories have revolved around quotes like this (from the ABC report) 'The Centre for Social and Economic Modelling has found on average women aged 45-60 are retiring with just $8,000 in superannuation whereas men retire on an average of $30,000'.
$8,000 or $30,000 in superannuation is chump change - almost not worth having. The age pension for individuals is about $13,000, a little less for each member of a couple, and this is what people these people will be relying on in retirement, unless they have substantial assets outside of superannuation.
Amongst all the bleak commentary on low superannuation balances, some other realities have been missed. The first is that it is quite easy, with a few years of extra savings, to increase your superannuation balance. Superannuation remains the most tax effective investment environment that is around - it you use it well, it is very effective. The second aspect that has not been commented on is that amongst the proposed superannuation changes the centrelink assets test will be relaxed. This means that retirees will be able to have a higher level of assets and still receive some part pension to supplement the investment earnings from their superannuation and investment assets.
Superannuation remains the most tax effective investment environment. The things a successful investor will do to take advantage of this include:
- Making some additional contributions to superannuation early in their working life (if they are eligible)
- Use the Government Co contribution if they earn less than $58,000 a year
- 10 years from retirement start making extra superannuation contributions - using the tax effectiveness of salary sacrifice contributions
- Don't lose track of superannuation funds, roll small funds into one good superannuation fund so that you are keeping all of your assets in the one place.
Monday, October 23 2006
Forbes put together an interesting sideshow that looked at the recent history of the Dow Jones average. It is available here. The Dow Jones is an index that measures the performance of a small group of the largest shares trading in the United States.
There are a number of interesting factors on show with the presentation.
Firstly, the Dow Jones average fell about 35% from its high of about 11,700 to a low of around 7,500 from the start of 2000. This is a fall of about 35%. This is something that investors in growth assets should keep in mind: they are volatile and a fall of such a magnitude is possible.
Secondly, the Dow Jones average has now recovered to above 12,000. That is, it is setting new record highs. So those investors who did not panick and sell at the bottom of the market, have actually seen their investment grow in value.
Thirdly, investors who kept adding to their investments regularly would have been buying assets when the Dow was valued at 7,500 - and these assets have appreciated in value by 35%.
Lastly, a comment on the folly of timing the market. When the Dow was a 11,700 there was more wealth invested in the market that at any time in history. And at 7,500 there was 35% less wealth invested in the market. However, 11,700 was a poor time to invest, and 7,500 a great time to invest. It shows how tough market timing is.
Thursday, October 19 2006
The US market, measured by the Dow Jones Index, broke through the 12,000 barrier this week - a record high. The reaction of a lot of people when investment markets hit a record high is that they must be overpriced.
The previous record highs that have been overtaken by the Dow Jones were in 2001 - 5 years ago. Since then corporate profits had rebounded, and the market is far more deserving of a new record high.
What we know for sure is that, over time, all growth markets (Australian shares, listed property trusts, international shares) increase in value. So we should expect that markets will keep on reaching record highs over time. I am not saying that a market that is setting new records is not overpriced - its just that you can't assume that it is!
Tuesday, October 17 2006
This post is about forecasting. It looks at some very recent returns from both Australian shares and Australian listed property investments. Returns that I did not hear anyone forecast.
In the last three weeks Australian shares have increased in price by about 7%. A fairly impressive run. Given that shares are paying dividends of about 4% a year, combine the 7% growth with 4% income and it will give an 11% annual return. Basically a whole years expected sharemarket growth has come in three weeks.
The problem is for those people trying to pick and time the market. Those people who said after July 1 that after 3 years of good returns there were no more strong returns to be had and sold out of the market. By trying to time the market that will have missed out on another run of very good returns.
In the quarter to the end of September listed property trusts were a strongly performing asset class. The return on the ASX300 Listed Property index was 10.6% - in a quarter! That is a strong result by any standard. I do not remember anyone forecasting it. Once again, if you missed it you have missed a great period of investment returns.
The moral of the story is this: don't try to pick and choose asset classes. You can so easily miss great periods of returns if you are wrong - significant returns can come in the matter of weeks. Instead, expose yourself to growth assets, diversify, accept the ups and down of investing - and keep a long term focus.
Sunday, October 15 2006
Vanguard have recently updated their 'Index Chart', which provides the details of the actual performance of various asset classes over time.
The average performance of each of the growth asset classes from July 1970 to now has been:
- Australian Shares - 13.3% a year. $10,000 invested in July 1970 is now worth $508,000.
- International Shares - 13.7% a year. $10,000 invested in July 1970 is now worth $551,000.
- Listed Property Trusts - 14.9% a year. They have only been around since the early 1980's.
Here is the point of all of this - all growth asset classes have produced remarkably similar returns. Listed Property Trusts appear to be a little superior, however they only started in the late 1970's/early 1980's and therefore missed the poor market returns of 1973/1974.
How does this information help us invest our money today?
First of all, the long term returns from these asset classes have been attractive - enough for any person who invests some of their money regularly to create significant wealth over a lifetime.
Secondly, because the returns from all three growth asset classes are remarkable similar, we don't have to worry about picking and choosing which one to invest in. We can invest in all three. This strategy will help us reduce the overall volatility of our portfolio, because as one asset class is performing poorly, there is a chance that this will be compensated by another providing a better level of performance.
Should we favour one asset class over any other? I tend to favour Australian shares, based on some research that suggests the benefits of franking credits are actually an 'unpriced' benefit. An example growth asset allocation might be:
- 40% Australian shares
- 30% International shares
- 30% Listed property
Thursday, October 12 2006
Yesterdays Australian Financial Review (12th of October) carried an article saying that the Macquarie Film Investment Trust was in the last stages of being disbanded. The trust had been involved in a number of poorly performing films, no films that have ever really made any money, with the whole exercise simply not working.
Why did people invest in the first place? They invested, I would suggest, at least in part because of the tax effectiveness of the scheme. However they are now in big strife, looking at a final return of around 10 cents in the dollar.
The moral of the story is to not be blinded by the tax situation of an investment and that, even a financial services company as well regarded as Macquarie does not guarantee success!
Monday, October 09 2006
The T3 Float is up and running.
The prospectus is out (just - apparently the friction between the Government and the Telstra board nearly got in the way of it).
I listened to Roger Montgomery, of Clime Asset Management make some really valid comments on an ABC TV interview. His first comment was that this is a company already listed and trading - if you want to own in you can simply buy it on the market. In fact, even with a 10 cent discount for retail investors and, say, another 10 cent discount because of buying into the float then the price of the shares based on todays price of $3.70 will be $3.50. Telstra shares were trading for less than this 3 weeks ago. He also made the comment that this is hardy a company without problems. The friction with both the Government and regulators part of the problem, as well as a competitive marketplace.
You can get a copy of the prospectus here. You will notice on the front page a lot of people smiling. I guess that these are either people who did not buy into Telstra 2, or investment bankers who are about to share in the big pile of fees generated from the Telstra 3 float.
The 14% dividend yield is emphasised in the prospectus. It reminds me of another float some years ago where the dividend yield was emphasised - the Australian Magnesium Corporation float. The Government propped up a dividend that was meant to look like the company had solid and reliable earnings, when it was really a start up company, and the company more or less collapsed. The Telstra dividend is not currently covered by company earnings, it has a bit of the 'phantom dividend' nature about it.
So, should you buy into the float? Remember that you are becoming part owner of a company if you buy the Telstra shares. The company is still squabbling with its biggest owners, the Government, and with the regulator. This can't be good for business.
My thoughts: don't get carried away with the excitement of the float. You can buy Telstra shares today, tommorrow and into the future. In fact, if you weren't buying shares at $3.30 a couple of weeks ago, I am not sure why you would buy now? Most of all, you need to come to an opinion about whether the company can return to profit growth. If you think it can, then it is probably a reasonable buy. If you don't think it can, then keep your money for other opportunities.
Sunday, October 08 2006
The Sun-Herald runs a four week competition that they call 'The Shares Race'. Eight tipsters choose a 10 stock, $100,000 portfolio and sees how that portfolio performs over the four week period of the competition. Aside from the absurdity of a 4 week timeframe for a share investment, the results are interesting to look at - and to see if we can draw any conclusions.
The average portfolio was valued at $101,585 at the end of the four weeks. During the same time the ASX200 total return index had increased in value by 4.1% - meaning that $100,000 invested in the index over this period would now be worth $104,107. The market easily outperformed the far less diversified portfolios.
Another interesting fact is to look at those people who should have had 'skill' in the game - the two last place getters in Richard Pritchard, described in the article as a 'Chartist' and Angus Geddes from Fat Prophets - a share investment reseach company. Richard's portfolio was worth $92,254 by the end of the 4 weeks, and Angus' $98,463. This suggests to me that there is little reward for skill in the market - these guys got hammered by an astrologer ($102,304 and more than $10,000 ahead of the chartist) and the dartboard with $98,636.
While I don't think we should read too much into a 4 week game, it is interesting to see how well the 'market' performed against some of the best and brightest in the financial services industry, and to see how poorly the 'skillful' participants faired.
Wednesday, October 04 2006
The US Market - measured by the Down Jones - last night hit an all time record high. The question, then, is what does this mean for investors?
Please don't be dissappointed when I tell you that it means nothing.
I am constantly surprised by the number of people who assume that because the market is at a 'record high' that it must be expensive. Have a think about it, if markets provide average positive returns of around 12% a year, then the expectation is that they must keep hitting record highs over time.
That does not stop investors from selling out of a market when it hits a record high. The number of people I have come across who sold out of the Australian share market after it had risen about 50% from its 2003 lows is surprising. This happened in early 2005. However, did they take into account the growth in earnings by companies over that time? Did they consider how far the markets had fallen prior to 2003? And, now that share returns have been a further 40% or so (when dividends are included), how do they plan to get back into the market? Remember - not only have they missed 40% in investment returns, they would have had to pay capital gains tax as well. This tax would not have to be paid if they had not sold out of the market.
One great resource to use in seeing how markets increase over time is the Vanguard chart showing the returns of the different asset classes over time. You can order one from the Vanguard website here. It is titled the 2006 index chart.