Ask Alan: 25 July 2019

G’day. Welcome to this week’s Ask Alan. It’s great to see you, thanks for joining me and here we are now. Remember the live stream today is general advice and it may not be appropriate for you so please bear that in mind and if you’ve got any questions as we’re going along please feel free to pop them in and I’ll get to them before we finish. As we speak, in fact right now this minute, the Governor of the Reserve Bank Philip Lowe is getting to his feet at the Anika Foundation annual lunch and talking about inflation targeting and monetary policy which will be a bit of a big deal I think, although he probably won’t say anything new but it’s always worth looking at and I hope he’s got a graph or two I can show on the news tonight because Reserve Bank Governor’s speeches usually have. So that’ll be good but I’ll write about that in this week’s briefing if there’s anything to write about and talk about it on the news tonight. But anyway, let’s get stuck into the questions because we’ve got some rippers today and the first one is in that category from Sue. Thank you, Sue.

Hi Alan. This time last year I decided to give some very successful fund managers a go with a small part of my SMSF, so WAM (WAM Capital), FGX (Future Generations), Munro Global, Bennelong Concentrated Equities Fund and Mirrabooka all failed, however Loftus Peak made a small gain. Fortunately, my ETF in the ASX 200 performed brilliantly so my SMSF still has had a good year. Why did the Funds perform so badly when the ASX did so well, while the crystal balls were all wrong? I note that Munro seemed to be very cautious about next year. Where can I buy a good crystal ball??? Thanks, heaps, for your very interesting insights.

Well Sue, this is a really interesting and good question. The first thing to say is that as we at InvestSMART often say, active fund managers tend to on average underperform the Index by the amount of their fees so that’s kind of what happens over time on average. The ones you chose are good ones, I think. Future Generations is a fund-of-funds, Munro Global run by Nick Griffin terrific fund, WAM is Geoff Wilson, Bennelong Concentrated Australian Equities Fund is Mark East and Mirrabooka I don’t know those people.

Anyway, you’re right, they all failed, they did terribly. In particular they did terribly this year from 1 January and what happened was that the Index went up and most of them went down or flat. Now this is the thing about investing with active fund managers because you’re getting human decision making, human imperfections, and what happened was that a lot of fund managers, and in particular the ones you mentioned, were shaken up by what happened in the market in the last quarter of last year, a big correction, a 20 per cent or so correction. And in particular the global managers, people like Nick Griffin and so on, they kind of went into their shell, they got a fright and they pulled back from the market and went a lot into cash, they went very defensive, and they got caught out by the fact that the Fed ran to the rescue of the market and started talking about, didn’t do it, but started talking about cutting interest rates on 3 January.

They basically pulled the market out of the dive that was there and the fund managers were caught short, they didn’t see that coming. Basically, what happened was the Fed caused the correction by talking about interest rates going up back in October and then Jerome Powell did a full 180 degrees in January and “whoosh” off they went so those fund managers got caught. Now I don’t know what all their positioning is now, whether they’re back in the market. I do talk to Nick Griffin a bit and Munro is back fully invested more or less, 80% invested, so he’s actually not cautious, Munro, he doesn’t know quite where you get that from Sue. He says he’s not cautious about next year, he’s back in the market, back putting as he put it “his money to work”.

Maybe he’s going to get caught again by the market going down but anyway that’s where he’s positioned now, he’s not cautious, he reckons things are going to be okay now because the Fed is cutting interest rates and is likely to keep doing so. So that’s what happened. I mean those fund managers you mentioned got caught. Now the thing to bear in mind is that the human frailty that we’re talking about that ETFs don’t have is that all those managers don’t want to lose your money so the reason they kind of pull back and get cautious is that they’re afraid of losing more of your money whereas Indexes don’t think at all, they’re dumb, they just kind of go up and down according to the market and so the market roared back, a lot of those fund managers, a lot of fund managers, got caught out because they were scared of losing money, they were scared of the market tanking even further because they didn’t expect the Fed to ride to the rescue as it did.

Rob says Hi Alan. With the residential housing market supposedly bottomed out are there any good ETFs/REITs/stocks, etc, that might be worth considering investing in that concentrate on residential property or is this view too short-sighted? Has the market already factored in a rebound into their pricing?

Well obviously, there are three stocks that concentrate on residential housing, one is REA, another is Domain (DHG) it’s actually now a subsidiary of Nine but it’s separately listed, it’s the REA competitor for listings, and also the listed real estate agent, McGrath. Now McGrath has been a shocking investment, in three or four years they’ve gone from $2 to 20 cents so they’re now a tenth of what they were. REA, on the other hand, has been a terrific investment, they’ve doubled in the past three or four years, they’ve done great, and Domain has been okay as well. All of these real estate agent listings firms rely on listings not prices, listings are well down. I don’t know whether the listings have bottomed, that’s a different question to whether prices have bottomed although they are obviously related, people tend not to sell their houses when prices are low which is where we’re at and at the moment, listings have been terrible, and as prices rise people tend to list more and they’re more inclined to sell so there obviously is a relationship between prices and listings but it’s not absolutely 100% relationship.

So yeah, those companies are residential property. As far as I can tell there are no REITs, real estate investment trusts, that are listed on the Stock Exchange that invest in residential property, most of the REITs, in fact all of the REITs I think, are commercial property. There’s one company that I’m an investor in, a slightly long-suffering investor, since it started which is DomaCom and its proposition is that it’s a fractional property investment vehicle, it’s a listed company, DCL, so you can either invest in the company but the shares haven’t done anything, I don’t know if they ever will to be honest.

The shares are about 10 cents which is my entry price some time ago so I’ve done nothing there, but anyway they might come good. It’s basically an investment fund management business, they make basis points on the amount of money in the funds and the funds that they have are residential property funds. In fact, what they have, they buy a house and they set up a unit trust and people can invest in that house as a fraction, you can buy 10% of the house or 20% and so on. So there’s two ways of using DomaCom to invest in residential real estate, one is to buy the shares in the company or you can invest in one of their residential property trusts which is an actual house. So you could buy if you wanted to 10% of the house and invest that way and you could actually get a geographical spread. The trouble with investing in residential real estate of course as you know is that you’ve got to put a whole lot of money into a house or a flat in one place, it’s difficult to get diversification and it’s one asset class that’s a large part of your portfolio and I mean obviously it’s usually geared. So you can use DomaCom to invest in a spread of geographic and types of properties if you wanted to depending on what they’ve got going at the moment. The other one that does that is called BrickX, you can Google that. They buy a house and they divide it into 10,000 what they call “bricks”, I think they’re units in a trust, and you can invest in a certain number of the bricks, that’s their way of doing it. I don’t know much about them so I don’t know how well they’re going and I presume as house prices fell investors in their bricks didn’t succeed. But if the market’s bottomed that’s maybe a way to get some exposure to residential real estate without actually buying a house or an apartment.

George says, always enjoy your weekend briefing. Lately it seems to be all doom and gloom with interest rates going lower. Where is it all going to end? Where is it all going to end?

Well we all want to know that George. I’m not sure it’s all doom and gloom really. I do think interest rates are becoming lower, that’s not a blinding insight, and what I’ve been saying is that it’s great for investors because what we’re getting is economic growth and lower rates which are supporting P/E multiples and I do think that’s going to go on for a while. The market is a bit high that is true so I think a lot of the value is in the market. I don’t think there’s going to be much in the way of tremendous returns but I can’t see a reason for suspecting a bear market is on the way. In fact, I think that central banks have abolished bear markets, they’ve decided that we’re not going to have them anymore so that might work for a while. I mean it won’t work forever of course, there’s always going to be imagined corrections and crashes and bear markets through history but central banks are doing what they can to stop them and so far, so good. Every time the market has a heart attack they come in with defibrillators at the moment and get it going again so that’s certainly the way things are going. So I’m not really all that doom and gloomy to be honest but anyway I’m interested in your point of view George.

Stuart says, Hi Alan. When Constant Investor was merged with InvestSMART I looked up the company, and behold, what unfortunate performance over the last year on the ASX by InvestSMART. I was wondering why a company meant to help create investor wealth isn’t doing it for its own shareholders? Anything you can enlighten me with? I know the question makes me sound like an arsehole but it keeps recurring on me.

Well yes, it hasn’t been great, the price is down to not very much. In fact, it was about 20 cents when I joined last year in about October and currently 7.5 cents, it was down to 6 cents, at the start of last year 30 cents, so yeah it hasn’t been great. So here’s what’s going on. So when InvestSMART began a long time ago, possibly almost 20 years ago, in fact it is 20 years I think, the idea was to set up some way for investors to invest in managed funds for a fixed dollar price, that is to say, the way they did it was, and this was started by Ron Hodge, the idea was that they would take the trailing commissions that fund managers paid and rebate all of the trailing commissions except for a $200 and that would be their fee. So basically, when you invested through InvestSMART into the funds it wasn’t a percentage fee, it wasn’t trailing commissions, you got the trailing commission back, and all you’d paid was a couple of hundred dollars to InvestSMART.

I thought it was a fantastic model at the time. Not long after that I started at Eureka Report. Certainly, I was campaigning against trailing commissions in my columns for Fairfax at the time and I saw a bit of Ron Hodge in those days because I really liked what he was doing, it was great, because I thought it was a really good way to deal with the problem of trailing commissions. Although it didn’t really resolve the inherent conflict of interest that was caused with financial advisers at least it provided an alternative to financial advisers so you could invest in funds and not be troubled by the conflicts caused by trailing commissions so I thought what Ron was doing then was great. Obviously, InvestSMART has been through lots of ownership, it’s now listed on the Stock Exchange, and since the Royal Commission basically a year ago or 18 months ago it’s been clear that grandfathered trailing commissions which is what now InvestSMART gets a fair bit of its revenue from, because obviously there are no new trailing commissions being paid by anybody because they were abolished by the Future of Financial Advice legislation (FOFA) but FOFA grandfathered existing trailing commission deals and that included a lot of what InvestSMART was doing.

If you go into the InvestSMART accounts you’ll find I think it’s about $4 million, maybe $4.5 million, of revenue coming from those old grandfathered trailing commissions which is that bit that they keep. It’s a relatively lucrative business however the Royal Commission has recommended that the grandfathered trailing commissions be abolished and it’s expected that that will happen. It hasn’t been announced as a thing that’s going to happen, they haven’t put a date on it yet, but the market is expecting that to happen and that will mean that a fair bit of InvestSMART’s revenue goes away and that’s why the shares have been falling in anticipation of that.

Here at InvestSMART we’re all focused on replacing that revenue both with subscriptions to the Eureka Report and the Intelligent Investor and in funds under management which is the ETF capped fee ETF products that I’ve been in favour of as well. So once again Ron has launched a capped fee product which is the $451 fee product in ETFs which is the reason I’ve come back really. I mean once again I really support what Ron’s trying to do there, not have percentage fees, cap the fee at $451, and that’s really the future of the business.

Now when I interviewed Charles Leyland who’s the biggest shareholder in InvestSMART through Leyland Investment Management last year one of the things he said was “These guys at InvestSMART are the good guys in the industry”, and I think that’s true, and that’s why he’s invested in the business. He’s lost a fair bit of money so far but he’s still confident in it, he’s staying with it, and that’s why I’m here too. There is a problem, the revenue from grandfathered trailing commissions is going to go away, however nobody knows quite when and the market is reacting to that. We’re all focused on making sure that that revenue is replaced and we are very confident that that is what’s going to happen. Is it a buy at 7.5 cents? Well maybe, personally I think it is.  Yeah, I do think it is and I’m pretty well exposed to the business obviously.

Mark says, why doesn’t the Intelligent Investor portfolio tool allocate percentage of shares into better asset allocations based on revenue source maybe? It seems that shares listed on the ASX are just allocated as Australian assets when in fact shares like CSL, BHP, CYB, etc, all have significant international exposure and are also listed on overseas markets. If a relevant percentage was allocated by II rather than everyone being forced to do it manually it would assist us to more accurately determine our international asset allocation. It would also mean that some of the erroneous info that is being put about overexposure to Australian shares versus international shares would be corrected in my opinion.

You are absolutely right Mark but I’ve got to say that II’s not the only one who does that, all of these asset allocators and fund managers and so on regard anything listed on the ASX as a domestic Australian share which in many cases it isn’t. In fact, CYB you mentioned, it is listed here and it’s still listed in London but it’s basically a UK bank, nothing to do with Australia, so it is an international share for sure. CSL, BHP, international companies, no doubt about it and there’s an increasing number of stocks, companies that are listed on the ASX that are basically international companies whether it’s American or Israeli or Chinese or so on. I mean there’s tonnes of them, hundreds of them, and I think you’re making a really good point. I will talk to Nathan Bell who’s running II and see what we can do about it. Maybe there’s another way because I think it would be wrong to completely shift the asset allocations to be based only on revenue source rather than domestic exchange. I mean it’d be hard but it would also perhaps be the wrong thing to do because it would put it out of step with all other asset locations so you wouldn’t be able to compare the II allocation with other fund managers and other research houses. But I think it might be a good idea to give an alternative to say “Here’s the asset allocation based on home exchange and here’s the asset allocation based on revenue source” and I think that would be good information for everyone to have and I appreciate your raising the point Mark, thank you.

Nitin says, Hi Alan. I did a bit of research on FLC and PET after last week’s Ask Alan podcast, and this is not a question it’s just some information, which I thank you Nitin. FLC is a US based company, Fluence, with no operation in Australia, they only have a distributor agreement with Aquatec. Why on earth are they listed on the ASX and not in the US?

Well as I was just saying there’s tonnes of companies now that are listed on the ASX because it’s a good place to list. A lot of American companies in particular are seeing the ASX as an alternative to NASDAQ because it’s easier to get listed, you can be smaller, it’s cheaper and you’re getting access to good capital and good listing. So the ASX is trying to become some sort of global technology exchange in addition to obviously an exchange for Australian stocks, so they’re going around actually recruiting businesses to list on the ASX and Fluence is one of them. The motive is that they need to be listed somewhere, or want to be listed somewhere, can’t get on the NASDAQ because they’re too small or it’s too expensive so they go for the ASX. I mean there’s not many other alternatives to be honest, there’s Singapore and that’s kind of it really, and the ASX is filling the breach. PET, that’s Phoslock, has CSIRO technology and is run by Australians. Yes, it is, and it’s been a fantastic stock in the last six months.

Sandra says, hi Alan. I have a question about the best options for investing for children aged three and five. We have been gifted $25,000 for the kids by a very generous relative. I would have liked to keep it in the kids’ names but the tax rates are an absolute killer. My top marginal tax rate is 32.5 cents. I’ve been tossing up investment bonds and blue chip shares but I’m having trouble deciding. Any thoughts would be appreciated.

Yeah, the tax is a killer. It’s really difficult and you’ve really got to talk to an accountant to get the structure right. I mean I’ve been through the same thing for my grandchildren and I’ve basically been stonkered really. I don’t want to cause myself or anyone else a tax problem which is what happens when you put it in their name, so yeah. Investment bonds, yes, except last time I looked at them the fees were prohibitive so check it out, be careful. I mean they’re a good structure in principle it’s just that because of the tax advantages the promoters of them take huge fees. Blue chip shares, yes. The best way to do it would be some kind of ETF or fund. You might want to look at something like Future Generation which pays the fees to charity, they support charities at the same time. There’s a few of these, there’s one called Sohn Hearts & Minds which is a medical research fund, Future Generations which is charity, and what happens with those is the fund managers contribute their expertise for nothing and the fee goes to charity. So you pay the same fee, you get the same performance, but the fee goes to charity. That might be something the kids would appreciate, the question is how to structure it so that you’re not mucked up by tax and I really think the best thing to do is to talk to an accountant about that assuming you have one. Those are my thoughts on that matter.

Norbert says, hi Alan. I was a subscriber to Eureka Report then followed you on the $200 a year system and now followed you again to InvestSMART.

Well that’s very nice. Thank you very much Norbert.

Number one, PNC, Pioneer Credit. I’m a long-term holder but I’m worried about their clumsy handling of the asset valuation earlier this year which prompted a big price drop. The last six months I hear or read constant comments about takeover moves. Can you shed any light or interview them? The CEO is rather arrogant and up himself being a big shareholder in his own right.

Well he’s probably not the only CEO who is up himself. Anyway, Pioneer Credit, an interesting business, it hasn’t done great and they were approached by Bain & Co which is a private equity firm, they made an offer I think or made an approach. The Bain offer was leaked, it was written up, the Board said “Crikey, we better have a process”, so they had a process and apparently the deadline for bids under the process is tomorrow. So it shouldn’t take long now to find out what’s going on, whether they actually do sell the business or not. You’re probably going to be out of your misery fairly soon Norbert but I will definitely interview them, the CEO, and perhaps bring him down a peg or two, I’ll give him a rough time. Anyway, I’ll interview the CEO as soon as they announce something which may be next week.

REE, Rare Earths [unclear 0:27:11.5] independent analysis and appraisal which suits your style, at least 10 players in this game now. LYC (Lynas) especially is at a crossroads with Malaysia being a lost cause for a process plant. They are talking to Blue Line in the USA as a possible JV partner.

Okay, I take your word for it. I don’t know much about rare earths, I actually thought Lynas was the only one. They’re certainly the only producer outside of China as I understand it but maybe there’s nine others that have some deposits that they’re trying to develop which is not surprising because China is kind of shutting down exports as a tool in the trade war so there’s probably room for some more producers I would have thought. But okay, all right, I’ll have a look, and we probably should talk to Lynas. I agree with you that that would make a good interview.

Fraser says, If AMP goes belly up is my life insurance policy safe?

Good question. I don’t think AMP is going to go belly up however anything is possible. I think they’re in strife, the shares are at a record low, keep falling, poor old Mr Ferrari can’t stop them going down and they’re going down faster than his namesake car. Let’s talk in generalities rather than AMP, if a life insurance company goes belly up, that is to say goes into administration or receivership, then the position of the life insurance policy holders is that they represent an asset of the business and 99% of the time the Receiver or Administrator would sell that life insurance book to another life insurance company and they would continue on as it were, so the policies would continue on. It’d be very, very unlikely that they just shut it up, they just closed it, and the policy holders lost their money or became creditors of the business. I don’t think you have to worry. I mean it’s theoretically possible that your life insurance policy is not safe however in reality the life insurance book represents an asset of the business and would be sold to another company.

Sue says, thank you for your answer regarding STW last week. Have you been able to find any further information? We are wondering if it has anything to do with lending shares to short sellers? We are very annoyed to hear that Vanguard are doing this. Is there anything unit holders can do to stop such action on the part of the fund? Do you think the fact that STW is dodging the question regarding franking credits that there is some kind of problem not being disclosed?

STW is the State Street ASX 200 Index fund I think, ETF. So for those who weren’t on last week, for the first time they paid a distribution they had no franking credits attached. Usually they’re about 80% franked because that’s what the ASX 200 average franking basically is but this time the franking was not available. Now Sue, I have seen a big statement by them as to what happened so if you would Google that or go to their website you should be able to find it, I mean it’s like two pages long, it’s quite a big statement. I’m not going to try and paraphrase it partly because I don’t really understand it. I challenge you to read it and come out understanding it to be honest. It’s not that clear to me what the hell’s going on. I know that it hasn’t got to do with short selling, it’s some other technical problem. They’ve promised never to do it again or something but as for Vanguard and others doing short selling, yeah look, I agree, I’m against it too, but I think the only thing you can do is – because these things aren’t a democracy – I think the only thing you can do is vote with your feet and sell, go into one that you know doesn’t lend stock to short sellers.

Craig says, hi Alan. Can you give any insight into the underperformance of the IS small cap funds?

No, I can’t I’m afraid, I don’t really know. I don’t even know what they own to be honest. I should know I’m sorry but I’m not on that side of the business, I’m not involved in the funds I’m just involved with the subscription businesses. It could be what I was talking about before with other fund managers that they went into their shell a bit at the start of the year and didn’t catch the updraft that occurred but really, I’m not sure. Maybe we’ll get Nathan Bell some time to come on here who’s running these funds to talk about them, maybe that’d be a good idea. In fact, let’s do it, I’ll get him on. We’d have to get him into Melbourne though because that’s where I am and he’s in Sydney. Anyway, I’ll see if I can do it.

That’s it, that’s all the questions that I have today. It’s been great talking to you, thanks very much for being aboard. Remember the live stream was general advice not personal and so it may not be appropriate for you. Thanks for your company this afternoon, I’ll see you next week.