More media misconceptions

In 'Don't take financial advice from a newspaper' we highlighted some of the ridiculous nonsense the mainstream media can come up with from time to time.

I hope Jessica Irvine doesn't think I'm targeting her (I'm really not) but earlier this week she came up with this doozy in Business Spectator (from 'Who's the bravest of the Big 4?')

'Banks are the plumbing of the financial system, essentially an infrastructure play.'

Perhaps her time in 'independent media' had her all at sea but I truly hope that no-one out there is investing in bank shares on the basis they're an infrastructure play. I've heard some interesting definitions of 'infrastructure' but this would take the cake.

CBA is a highly leveraged play on home lending (ie unemployment) and other financial services. The reason their earnings are stable is because they have multiple forms of Government back stop (guarantee, monetary policy and various housing boosts) and high customer inertia. The reason they can get a return on equity of 18% is because they operate on a debt/equity ratio around 1600%.

Their return on assets is around 1%pa. Leverage way beyond the capacity of any normal business turns this into a 18% return to shareholders. Any sort of half decent uptick in bad debts will turn CBA's balance sheet into a train wreck (that's the downside of extreme leverage). Adam Brandt's proposal to impose a 0.2% levy on bank assets would decimate the bank's profits.

CBA shares are a punt on these types of things not happening, not a boring revenue stream that goes on in perpetuity because people have little choice but to use the assets.

If you want to fly out of Sydney you have to use Sydney Airport. It doesn't need the Government to back it up and it doesn't have meaningful competition.

If you want to get a home loan there's CBA, the other big four banks, a myriad of foreign and regional banks, non-bank lenders and new upstarts like Yellow Brick Road. If you're looking for funds management, structured products or financial advice the world is pretty much your oyster.

Infrastructure stocks have leverage too, but nowhere near the same degree. Sydney Airport's ratios bounce around year to year but take Envestra as an example. With a debt/equity ratio just under 400% it manages to turn a 6% return of assets into a 13% return on equity. The leverage of Envestra doubles the return to shareholders, it doesn't multiply it 18 times over. A 0.2% Adam Brandt levy would reduce profits, not destroy them.

None of this is to say bank stocks are necessarily bad. They're just not infrastructure.

Following on from 'banks are an infrastructure play', ABC's 7.30 report on Wednesday night contained this 'doozy of the week'. Tom Garcia of the Australian Institute of Superannuation Trustees (in the context of a discussion about where $1m was a large super balance) came up with this absolute howler:

Even a comfortable retirement, you need about $500,000 to live - and that's $55,000 a year - and that takes you way past longevity.

I'm going to assume Tom meant to say 'life expectancy' instead of 'longevity', so he's only trying to make $500,000 last twenty years, not thirty to forty. Perhaps he was factoring in the age pension as well. The only thing that was clear from the statement is that he wanted viewers to think $1m was a very large super balance.

But on the face of it, the statement defied belief, since it would require a risk-free rate of return of 9%, with no inflation, to expect $500,000 is going to generate $55,000pa for another twenty years (assuming that is, in fact, the life expectancy). If you factor in inflation, returns would need to be higher.

Even if he was factoring in the age pension, the statement ignores the fact that many people aren't comfortable relying on the age pension, even as a back up. When our Government changes its mind on super every few months, who can blame them. There's nothing stopping them changing the age pension rules as well.

It's not too hard to envisage a scenario in the future where the Government decides that having $500,000 (or less) in super assets means you're wealthy and you don't need any age pension.

It's hard to tell from the name, but Tom's organisation has as it's stated purpose to 'promote and protect the interests of Australia's $500 billion not-for-profit superannuation sector'. Continued growth of SMSFs clearly doesn't fit well with this objective and someone with a balance over $500,000 is probably more likely to set one up.

Of course this whole debate ignores the fact that it's not the balance that's relevant but the income that can be generated from it. Lifetime annuities currently pay about 5%, so $1m would give you $50,000 for life - below average weekly earnings.

If you can't generate average weekly earnings after eliminating longevity risk, it's absurd to suggest $1m is the sort of super balance that should get special penal treatment. Maybe if the RBA stops playing with interest rates it will be able to generate an above-average income again. But who knows when that might happen.

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