Fureyous

A couple of weeks ago I presented to a large group of financial planners a Case Study on constructing a portfolio for a pension drawdown situation. The case study required an annual drawdown of around 10% of the portfolio balance which given dividend yields, current interest rates, and low expected return potential meant the portfolio situation was going to require some type of capital drawdown. To make things a little more difficult the hypothetical investor was classified as a ‘middle of the road’ risk type…or “balanced” investor.

So how should we construct such a portfolio? I would say most financial planners would typically set aside two to three years of drawdown into cash and invest the remaining assets into a balanced type portfolio or maybe a diversified portfolio with a little more risk given the cash allocation. A second common solution is simply to invest the whole lot into a balanced portfolio and draw down across all asset classes so as to maintain the Strategic Asset Allocation that matches the balanced risk profiile. The problem with both of these solutions is that they are quite inefficient due to the possibility of being forced to sell equity positions within three years to fund cash flow.

My proposed solution, put forward for the purposes of discussion, was to firstly satisfy the investor’s cashflow needs with a minimum of five year Nil RCV (i.e. expires at end of term with a zero balance) annuity and with the remaining funds invested in a high growth equities only portfolio that will hopefully grow sufficiently to replace the annuity at maturity. To me, having a minimum of a five year timeframe for an equities portfolio is a lot better than between not much and three years which is largely the current practice. It may not be the perfect solution but satisfying a client’s cashflow needs for at least the next five years is very attractive to most investors and a lot easier to manage.

The response I received from the audience was quite disappointing and could be summed up by two themes…

1. Thoughts that the strategy is non-compliant, and
2. Existing systems made recommended such a combination difficult

In terms of non-compliance the audience felt that because the asset allocation shifted to 100% High Growth portfolio at the end of the annuity term that it was non-compliant. This is completely false. An investors asset allocation changes every day and there is absolutely nothing in legislation that suggests rebalancing must occur or that an investor’s asset allocation must meet the corresponding Strategic Asset Allocation over time. Once again, what the proposed solution provides is a satisfied client in terms of cashflow for at least the next fiveyears from an annuity and a second portfolio that is designed for growth over that same period so as to, hopefully, continue to provide income for a lot longer. This strategy is completely compliant and first and foremost meets the client’s needs. If the client has concerns then it doesn’t matter what the risk profile of the client is these concerns must be addressed but that is a separate issue.

The second point disappointed me most. Whilst Nil RCV annuities are not currently available in master trusts or wrap platforms that is once again quite irrelevant to the client’s needs. If existing systems don’t quite make it easy for paraplanning or ongoing reporting then tough luck…if its the best solution for the client then a bit of additional work for the client’s benefit should be considered…in fact perhaps it is justification to charge additional fees.

My general observation in recent years of the methods of portfolio construction for the retail investor in this country is that portfolios are designed to firstly be compliant within business rules and secondly to match client’s needs and unfortuantely the thoughts around compliance get a little bit carried away. Client needs must always come first and if they are met and all risks and fees are disclosed and the client is still happy then there will never be a problem. Throw in some ongoign communication and needs reviews and if the strategy still applies then it should be happy days.

   Send article as PDF   

I hope I don’t use this forum for my consumer complaints too often, but I have to vent my frustration regarding my Omega Seamaster watch. Despite being a fairly expensive piece of equipment, it was losing around 5 minutes per month so after missing one too many trains I decided to return it to the shop where I purchased it.

As expected they sent it away and advised it would take “around 4 weeks”…its almost 8 weeks now and yesterday I was advised that “it is in the final stage of ‘quality control’ and should be ready by the end of next week, which is Xmas after which we close so it should be ready in the New Year”…mmm…10 weeks after a promise of 4…boy do I hope it keeps better time.

   Send article as PDF   

From 1 November 1980 to 31 October 2009, a total of 29 years, an investment in bank bills would have yielded a total return of 1,257% which is an annual return of 9.41%…many banks provide this type of return for their customers and as we have found out in the last year or so, the Australian government is happy to protect your deposits when times are tough so the risk is very low and bank bill type returns are achievable for all of us.

Compare this to the return of the All Ordinaries Index….which is the best proxy of the broader market as it encapsulates on average around 500 of the top Australian companies…which returned 1,996%…better than bank bills…however…the annualised return is only 11.06%. This annual return represents a risk premium of only 1.65%pa.

For the average punter, access to managed funds is typically done via master trusts or wrap platforms, and guess what….their total annual product fees (which include administration, fund manager, and advice fees) are typically around 1.9%pa for an investment in an Australian Shares fund. Therefore, if you made an investment into the Australian sharemarket at the start of 1980, (which opened with around a 50% first 12 months return), you would have underperformed bank bills by paying the fees that current platforms charge adn most importantly with more risk!

No wonder the Cooper review and government will insist on fees being less than 1%pa.

   Send article as PDF   

The year 2009 has turned out to be a significant turnaround year for the global economy and sharemarkets. At the start of the year, the word depression was mentioned often as many economists, investment professionals and politicians thought entering the world’s second great depression was a potential reality. Thankfully, around March 2009, “green shoots” of the global economy started to appear and whilst they haven’t blossomed into anything too beautiful, we have at least witnessed the emergence of many other “green shoots” that have improved conditions in credit markets, share markets, and in the US some positive signs in their housing market.

Sharemarkets bounce…
For investors in sharemarkets, the year 2008 was one they would rather forget and this continued into the first quarter of 2009 where the S&P/ASX200 index bottomed at the start of March. This was the lowest level for the sharemarket since 2003 but despite a lot of paper talk of the market potentially going lower, as is often the case, when the news out of the sharemarket is at its worst prices start to rise. Although the news continued to be bad it wasn’t as bad as expected and between March and October the S&P/ASX200 increased by almost 60%…an astonishing rebound.

The same was true for global shares despite the US, Japan, and Europe’s economic woes that continue today. For the global share investor, returns were also strong double digits. Unfortunately, for the unhedged investor, which is most of us, the strength of the Australian dollar reduced investors global sharemarket gains and many may well see negative performance for the 2009 calendar year.

Bonds subdued…
The economic “green shoots” that contributed to the increase in sharemarkets from March of this year also contributed to increases in interest rates. Unfortunately for the bond investor, an increase in interest rates results in the decline in the value of bonds. For the local bond investor the strength of the Australian economy resulted in some of the strongest interest rate rises in the world and overall returns for Australian bond investors may well be flat. Global bond investors have fared a little better as the overseas economies have struggled significantly more than in Australia and interest rate movement has been minimal to negative. As a result global bond investors may see annual returns between five and ten percent.

Economic Landscape…
The Australian economy has certainly fared very well compared to the US, Europe, and Japan and this is largely due to three main factors:

1. Strength of our banking system which is significantly more conservative than some of the largest banks in the world
2. Strength in our commodity export sector and geographci position close to Asia. This has provided the ability to leverage from the significant growth in China
3. Strength of our government’s balance sheet who in the good times had budget surpluses allowing these savings to be used for the tough times that turned out to be the global financial crisis

Looking forward it is near impossible to know how investment markets will perform but indications are that overall the global economy will be slow as global households continue to reduce debt and high levels of unemployment (which are expected to still rise) provide a drag on consumer spending. Whilst the global economy is improving there remain significant risks as evidenced by the default in its debt payments by Dubai World. Credit markets are far from normal and this is a strong indication that full recovery is a long way off yet.

In Australia, markets have priced in further increases in interest rates by the Reserve Bank with another 0.5% of rises expected by March or April 2010. Rising interest rates is a sign of strong economic conditions so with a bit of luck if there are no further economic shocks there is a stronger sharemarket into the first half of 2010. Given the volatility of sharemarkets this is far from a sure thing but on the positive side, we are coming from the worst global economic conditions since the Great Depression and we are still a long way off our sharemarket highs which were reached in November 2007.

   Send article as PDF