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 Financial Happenings Blog 
Tuesday, September 26 2006

The headline in the Courier Mail today read 'Super Run for Funds in August'.

The article then went on to espouse the great returns for super funds including:

  • Australian share funds an average return of 17.9% for the year to 31st August 2006
  • International share funds an average return of 13.1% for the year to 31st August 2006
  • Listed property trust funds an average return of 15.8% for the year to 31st of August 2006

What great results for investors!  Or are they?

Have a look at these figures relating to the overall performance of the market during these times.

  • The ASX300 share fund had a return of 19.59% for the year to 31st August 2006
  • International share index had a return of 14.5% (50% hedged) for the year to 31st August 2006
  • Listed property trust funds index (ASX300) had a return of 20.94% for the year to 31st of August 2006
  • In each case the average super fund SIGNIFICANTLY underperformed the simple index return.

    These results even surprised me.  Over a 1 year period I would have expected that funds got closer to the index than that.  What the results clearly show is just how tough it is to beat the market over a short time period - and over longer time periods the index will win by more and more.  It also shows that we should not be complacent even when investment returns are booming.  While the absolute returns of the super funds are fine, underperforming the index by a margin is not acceptable, because the option is always there for investors to use an index fund.

    The performance data for the superannuation funds was taken from the superratings website.

    Posted by: Scott Francis AT 08:25 pm   |  Permalink   |  Email
    Monday, September 25 2006

    Dimensional Fund Advisors provide key investment solutions for our portfolios. 

    Dimensional are an investment manager who focus on applying the latest in investment research to investment solutions.  Indeed, perhaps the strongest example of this in action is the fact that they have two Nobel prize winners on their board. 

    The basis of their investment approach lies in the fact that research consistently shows that 'small' companies and 'value' companies have a higher expected investment return over time.  Dimensional build portfolios of small and value companies that have consistently ouperformed the simple index.

    For example, over the 5 years to the end of August 2006 the index return has been 13.8% a year, the Dimensional Australian Value Trust has returned 19.3% a year and the Dimensional Small Companies Trust has returned 18.54% a year.

    An article of mine published in Alan Kohler's Eureka Report and available here provides more information on Dimensional.  The website for Dimensional Fund Advisors is available here.  There is plenty of excellent information about their investment approach at this site.

    Posted by: Scott Francis AT 05:49 pm   |  Permalink   |  Email
    Monday, September 18 2006

    Trying to forecast market movements is fraught with danger.  There is overwhelming evidence, academic and otherwise, that predicting market movements simply cannot be done.

    As an example, a recent Eureka Report edition focused on the expected returns from the Australian sharemarket.  The Eureka Report is an online magazine that I have a lot of respect for, and am a regular contributor to.  The headlines were as follows:

  • Charlie Aitken:  It's just Chicken Little . and another September buying opportunity
  • Patrick O'Leary: The ASX will be flat through 2007, and the sky might actually fall.

    и  The US fund manager: If there's no US recession, stocks will rally 25%.

    и  Shane Oliver: The savings glut is about to return ? that's good for shares.

  •  

  • There is a wide diversity of opinion there, from the sky is falling to a possible 25% return.  One of the problems with forecasts is that one of them is likely to be right, and we tend to assume that is by skill and not luck.  However, if there were 50 different opinions then one is likely to be correct, and the owner of that opinion will suddenly assume guru status - although dumb luck suggests some people have to get a forecast correct! 

  • How do we incorporate these forecasts into investment portfolios?  Simple - we don't try to forecast returns.  The long run returns from growth assets - Australian shares, international shares and listed property trusts have all been around 12-13% a year.  So exposing ourselves in a diversified way to all three asset classes will provide sound long term returns - without the hassel of worrying about short term forecasting, or the cost and tax inefficiency of buying and selling to chase forecasts.

  • Posted by: Scott Francis AT 07:06 pm   |  Permalink   |  Email
    Thursday, September 14 2006

    When we see the studies of investment performance, it is clear that active managed funds on average fail to beat the lower cost and simpler investment strategy of investing in an index fund.

    However there remains another factor lurking behind these reports, in the form of 'survivorship bias'.  Survivorship bias works like this.  If you are measuring investment returns over a period, say 10 years, then over that time some managed funds would collapse.  These managed funds are generally not included in the research.  However, the fact that they tend to fail suggests that their performance is poor, and therefore overlooked.

    A study by some professors from the University of Massachussets, which looked at hedge funds, provided some interested statistics on this topic.  Hedge funds were divided into 6 categories.  For those funds that failed, their returns were more than 10% lower than the successful funds in 4 out of the 6 categories.  The other two categories had differences of 8.9% and 5%.  This is a massive difference in performance, with the bad performance hidden from the public by the fact that the funds went out of business.

    This makes it hard for consumers to know what is happening in any part of the managed funds industry, as they are only hearing the story of the good funds, rather than the funds that have gone out of business and let investors down.

    I am not a fan of hedge funds at all.  They are basically trading funds, that rely on the skill of the expensive investment manager.  The fact that they are trading funds makes them tax ineffective.  I remain unconvinced of the existence of publicly available trading skill that will result in superior 10 year hedge fund returns against investing in traditional asset classes.  Hedge funds often sell themselves on the fact that the returns are 'uncorrelated' with other investment classes.  Betting on horse 2, race 3 is also uncorrelated with other investment classes, however I would not advise it.

    My thoughts: if you want to get rich start a hedge fund, don't invest in one.

    Posted by: Scott Francis AT 08:02 pm   |  Permalink   |  Email
    Tuesday, September 12 2006

    An article in today's Courier Mail (September 13) written by John McCarthy showed some of the seedy side of financial planning.

    The article related to complaints by financial planners who had advised clients to invest in Westpoint investments.  As we now know the 12% return offered from these investments was unsustainable, and the scheme collapsed. 

    Investors are seeking compensation from these financial planners through FICS (Financial Industry Complaints Scheme).  However the planners are complaining that this should not happen as the Westpoint investments were 'promissory notes' rather than financial products.

    What rubbish.  Financial planners let clients know about the FICS scheme as a way of settling disputes and, at the first sign of trouble try to wiggle out of it. 

    The investors came to the financial planners looking for advice on financial products, and the advisors decided that the Westpoint investments were suitable.  I am sure it was not the client who decided that they were passionate about investing in promissory notes.  Moreover financial planners should have nothing to fear provided that:

    • They explained to clients the high fees that they were receiving from Westpoint for the recommendations
    • They explained the risks related to investing in promissory notes related to mezzanine finance (a high risk bridging finance) so that clients were aware of the risks
    • The only invested a moderate amount of the investors capital into the notes, say 5%

    Of course, if the media articles are correct, any financial planner who represented the Westpoint investment as being 'safe' and 'like investing in a bank' should be in serious trouble for dishonest or incompetent advice.

    Posted by: Scott Francis AT 04:54 pm   |  Permalink   |  Email
    Tuesday, September 05 2006

    A little while ago I mentioned that the secret of compound interest was time.  That is, the effect of compound interest becomes more and more pronounced over time.  That is because compound interest is effectively the investment earnings on investment earnings.  And it takes time for the level of investment earnings in a portfolio to increase.

    It was great to see this in action when I came across this blog here.  This blog shows the people in question aiming to accumulate $1 million of wealth by the year 2016.  There is a lot of interesting discussion on their financial journey.

    What I found particularly interesting was the length of time taken to reach each financial goal.  Their first $100,000 took 5 years to accumulate, although at that time they were not as focused on financial goals.  The next $100,000 19 months, the following 11 months and the most recent 8 months.  They also received $100,000 as a capital gain from the sale of their house, taking their net wealth to above $500,000 currently.

    Each $100,000 became progressively quicker, at least in part because of the help that 'compound interest' was giving them.

    Posted by: Scott Francis AT 10:24 pm   |  Permalink   |  Email
    Friday, September 01 2006

    Last night Channel Seven ran an interesting article on the way cars lose value over time.  The results were interesting.  Basically cars fall in value by about 50% over the first three years of their life.  Some fall by a little less, some by quite a bit more.  In fact, of the big cars the best performer was the Chrysler 300c which fell in value by 53.9%.  Remember, that was the BEST performer in that class, the class that includes the traditional aussie six's.

    So what does that mean for our financial wellbeing?  First of all we should never, ever think that buying a standard car is an investment.  And secondly we should decide whether we want to buy a car before it falls in value over the next three years, or as a three year old car that is suddenly 50% (or more) cheaper than when it was bought.

    One emphasis that I have is that we should look at money as being a unit or work.  That is, if I am paid $15 a hour after tax then a purchase of $30 is equal to 2 hours of work.  That way we can decide as to whether we really think that we are going to get the benefit from our purchase that will justify the work that we have to put in.  Let us say that we want to buy a new car costing $24,000.  We now know that we can buy the three year old second hand equivalent for $12,000 (and three years old is still pretty new).  The difference is equal to 800 hours of work - or 20 full time weeks of work.  That is a lot or work just for that new car smell!  Of course, some people really into cars will say that is worth it, and fair enough too.  For me, I'd rather drive a second hand car and do 20 weeks less work.

    For more information on second hand car prices, the pre-eminent guide in Australia is redbook.com.au

    Posted by: Scott Francis AT 06:02 pm   |  Permalink   |  Email
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