In these articles Das eloquently articulates the major influences on the Australian economy (China, Europe, Cost of funding, commodites, etc) and breaks down how these could play out.  I enjoyed his comments on why Australia handled the GFC better than others

APRA and politicians take credit for the banks being relatively unaffected (during the GFC). This is curious given that banking regulations are largely uniform around the world. One can only assume that Australia has superior regulators and politicians to the rest of the world – an example of “Australian exceptionalism”.

In reality, Australia’s swift recovery was driven by large cuts in interest rates, government guarantees for banks, government stimulus and a commodity boom

and his concuding remarks cannot be discounted

Australia remains vulnerable. A slowdown in Chinese growth and fall in commodity prices and volumes would affect the economy adversely. Australian history suggests that mining booms are finite and end suddenly causing significant disruption.

Problems in sovereign debt and attendant pressures on banking system may decrease available funding and increase borrowing costs for Australian banks and companies. Overvalued house prices and high household debt increases vulnerability to an economic slowdown, with an accompanying rise in unemployment or to higher mortgage rates. A credit crunch or recession could cause house prices to fall worsening domestic conditions, which would in turn affect domestic banks.

The perfect storm for Australia would be the coincidence of those events.

Das mentions the key positives for Australia, which are our low levels of  government debt, interest rates with room to move, and the abillity for our currency to significantly depreciate. However the complacency that I believe exists in this country that I’m unsure we ackowledge is that just because we made it through the GFC and have had 20 years of consistent economic growth without a technical recession…

Australia’s economy remains vulnerable to a variety of external factors over which it has no control.

At last check the ASX today was 4267 so ifit grows to 5000 by the end of the year that’s a capital gain for the remaining months of a little over 17%. Throw in a conservative dividend yield of 4% and that’s a 21% return!!! I love to hear the big calls

Sure, if the European and US economies look to be sorted and China’s issues are fine then 5000 is very do-able…I hope he’s right…but it is a big if and there’s a long way to go before we should be remotely confident of a 21% return this year so be very careful of what fund managers say…perhaps there may be conflicting reasons?

Source: RBA

Its been a few weeks since I provided an update on the local government yield curve and consistent with the slight improvement in the sharemarket the Australian Government Bond Yield Curve has indicated a better outlook for the local economy. As the chart shows, since 6 January the yield curve has increased around 20bps across all maturities which isn’t a bad increase but yields still aren’t as high as they were last November.

Current figures still suggest the Reserve Bank will decrease its cash rate next meeting and the shape of the curve is consistent with weaker economic outlook suggested by the IMF and World Bank reports. It also suggests that inflation continues to be a non-threat and the ABS inflation figures showed that the market was pretty much correct by dismissing inflation over recent months.

Since October the S&P500 has rallied around 20% in the face of some pretty ugly political behaviour in both the US and Europe regarding their respective economies and that’s quite a surprise. This is also supported by the downtrend in the VIX…see below chart…given the current downside risks I tend to think this trend will reverse and volatlility will increase.

Source: Bloomberg

I don’t know what direction equity markets will go but my thoughts are to stay conservative…there’s a lot of water to pass under the economic bridge before catastrophic risks (global/European banking meltdown) is off the table. Whilst the market’s suggesting the risk is reducing its still there.

Also, I may have lost my RSS feeds which were linked to the old michaeljfurey.com domain so I am currently working on fixing this problem and will update this post once fixed.

RSS Feeds should be fixed…I used Feedburner for what its worth

To support their point, Lonsec say that they have added K2 Australian Absolute Return Fund to their model portfolio because, “K2 have a specific focus on downside risk in their portfolio by varying their market exposure within the fund. During a strong bull run, strategies such as K2 will keep their fund fully invested…then sell out of equities when they believe the risks are too great…”. Sounds great and K2′s overall track record is certainly one that many Australian fund managers would envy.

I’m skeptical of every fund so I conducted some in-depth performance analysis to understand K2′s performance drivers and most of the results certainly supported that they are a manager of skill. For example, since the end of 1999, K2 have outperformed the Australian sharemarket indices and achieved alpha of almost 5%pa whilst their market beta was a relatively low 0.66 (i.e. less risk than the market). It did have a small cap bias but my model showed that the market and small cap effect only explained around half of their performance with rest explained by other effects such as market timing…either way, great results for K2 since 1999.

Their relative performance since the end of the bull market (Oct 2007)  is excellent and this was totally explained by having low exposure to the market…beta less than 1 again plus very high alpha around 4%pa.

Where K2′s performance fell down was during the bull market from March 2003 to October 2007. Overall, they significantly underperformed the MSCI Australian Index by around 4,5%pa, but I guess it is difficult to complain when you receive 20%pa instead of the market’s 25%pa. My performance analysis showed that during this bull market K2 did not have the market exposure Lonsec claimed they would have (i.e. a beta close to 1) with a relatively low market beta of ~0.55 plus a reasonable exposure to small cap stocks. This low beta explains why they underperformed the market because during this time, K2 still were able to display skill with a strong alpha of 1% (after taking into small cap effects).

Anyway, in theory a variable beta fund could be a worthy addition to an investment portfolio if you are looking to outsource management of market exposure. I agree with Lonsec that K2 is an excellent fund for doing this job. The warning derived from my analysis is that, whilst variable beta funds (or a research houses) may tell you they will be fully exposed to sharemarkets during a bull market run, there’s always a chance they won’t hence they could significantly underperform the market during these times.

There is demonstrable portfolio improvement to be had from allocating to market neutral strategies as part of the equity allocation…

That says to me that if you want to improve your equities part of the portfolio then replace part of it with something that is not equities; or, if you want to improve your equities portfolio then diversify away from equities; or even more cynically, because equities have performed badly you should not have invested in equities and had some market neutral investments.

You see, if an investment is market neutral then its net exposure to the market, by definition is basically zero…or a market beta of zero. For example, if I invest $100,000 in my best stock ideas from the ASX200 and then short the ASX200 index by $100,000, my net exposure to the market is zero and therefore market neutral. I then take my $100,000 and invest it in something conservative like a portfolio of cash-like investments and the return I receive is a cash-like return plus the outperformance (or underperformance) of my best stock ideas.

So, as you can see, my return is not at all equity-like because my return equals cash plus alpha minus fees…which, given the fees are typically very high and over the long run alpha does not often outperform fees, means my long run return will probably be less than cash…but this is still a better return than shares over the last 4 years!!!

OK, believe it or not I don’t mean to suggest that market neutral strategies should never be part of an investment portfolio. Just that they carry is a very different type of risk than equities. So the decision to include market neutral strategies in a portfolio means there must firstly be a non-traditional approach to the asset allocation decision (i.e. the inclusion of “alternatives”) and therefore there must be a decision made as to which traditional beta risks must be exchanged for this market neutral strategy…I’m sure it will often be equities but it could equally likely be credit risk, property, or even other so-called alternatives such as commodities or private equity etc.

In the article there were a few funds mentioned that Zenith reviewed and some of them with quite good recent performance. Blackrock’s Market Neutral fund returned 28% over the last 12 months so there’s every chance both longs and shorts did reasonably well…as opposed to my example, Blackrock short stocks as opposed to the index as a whole. Despite that great performance it was quite muted in 2010, and underperformed shares in 2009. Market Neutral funds do have the ability to provide good returns but always keep in mind those returns are purely reliant upon manager skill.

My final comment relates to Zenith’s view on fees…

The idea that overall returns will be improved by reducing input costs relates more to industries such as manufacturing but doesn’t apply to something like funds management where there is intellectual property involved – so it doesn’t make sense to look at the MER rather than the net returns.

…and its something I strongly disagree with. With the failure of so many active managers to outperform their benchmark and not deliver on their promises, the easiest way to increase your return is with low fees. Hedge funds were found out over 2007 and 2008 and 2 and 20 has largely disappeared. Successful Funds management is very difficult and if you are good you will be rewarded with strong inflows and strong inflows can still fill the pockets of the greedy fund manager with more money than they’ll ever need…Ill save my rant on performance fees for another day.

With the movement to fee-for-service by the financial planning industry, thanks to the Future of Financial Advice (FOFA) reforms that kick off in July, ETFs are bound to be a very popular investment vehicle by financial planners so we will undoubtedly see further cost cutting by the platforms and further consolidation as the smaller platforms struggle to stay profitable.

This change of rules by the ASX is way overdue and whilst this initial move into bond ETFs is a small step…underlying bonds must come from only two Australian bond indices (UBS Composite or S&P Australian Fixed Interest)…its bound to start a significant change in behaviour in the financial planning and investment platform industries.

Art doesn’t have returns, it just sits there, being expensively insured. It pays no dividends, and it can’t be marked to market, since the only way to find out the market price for an artwork is to sell it. Even the auction houses have no real idea what any given artwork is worth: look how many pieces fail to sell at auction, or sell for multiples of their estimate.

I totally agree with this assessment and his article as a whole and as  Salmon’s article suggests this also applies to wine and I’ll throw into the mix any collectable such as vintage cars, stamps, and collectible notes and coins.

In 2010, the Cooper Review recommended that art should be banned from superannuation and pretty much for the same reasons…that collectibles are not investments and are personal assets. There was a lot of opposition to this recommendation with the art community protesting by suggesting it would result in the demise of the art market. The government ultimately didn’t accept the recommendation and that was that.

Whilst it is possible these assets can increase in value, they are a poor choice for providing retirement given Salmon’s reasons…no income, impossible to value without selling,  and little to no liquidity….and they are not investments. Also, I don’t believe that diversification of collectables is going to help too much either, as I can only imagine that by reducing the cost the collectable in order to diversify will result in increasing making it more difficult to sell… that is, increasing diversification may increase risk.

Whilst I acknowledge investors frustration at sharemarkets, I do agree with the Cooper Review and Salmon that collectables are not investments and in my opinion they should not be considered as part of a superannuation investment portfolio.

As the article demonstrates, the one-trick pony that Storm Financial influenced their clients with was a double gearing strategy whereby clients, would borrow against their home and then use these funds to further gear with a margin loan into sharemarket investments. Storm apparently charged fees that would typically amount to around 7% of the invested amount…i.e. appallingly very high. This strategy made millions of dollars for Storm and lost $3billion of investor funds over 2008/09. On this system the financial adviser is of the opinion (in her book) that, “Academically, it was the perfect wealth system – use someone else’s money to make money, buy low and sell high”

On this, I just have a few comments to make…

• This adviser clearly has no idea what academics think of this ticking time bomb strategy…there’s nothing academically rigorous about it
• Clearly, this adviser has no understanding of the volatility and return history of sharemarkets
• It was only the perfect wealth system for the financial advisers who collected disgustingly high fees for this massively risky strategy
• Avoid any adviser who flippantly uses the term, “buy low, sell high

I’m disappointed that somehow this ignorance hasn’t stopped this financial adviser gaining publicity  by appearing on various television shows including, Sunrise (Kochie should know better), The Circle, and The Project (usually the best current affairs show and run by comedians…go figure).

Finally, I cannot believe that her current passion is Financial Literacy and “lifting the sorry state of financial education in this country”…given the earlier quoted statement on the Storm system, this financial adviser should start educating herself and do this industry a favour and consider an exit…Yep, I am Fureyous that many of the best financial planners are not given the publicity that this person has undeservedly received.