Chris Lee & Partners Ltd

Market News 28 March 2022

I wonder how many businesses that were too slow to exit Russia after failing to pre-empt Putin's intolerable behaviour are now considering reducing their exposures in China?

INVESTMENT OPINION

NZX Rights – I'd like to compliment the NZX on its recent Rights issue to raise money for its business expansion, including the investment in the dairy trade platform and some debt reduction.

The strict 1:9 Rights offering offered unquestionably fair access to all current shareholders and offered professional investors the ability to increase their exposure to the company via the underwrite agreement.

The NZX paid a fee to those professional investors for an assurance that 100% of the new shares would be purchased at the $1.42 issue price, regardless of market conditions.

If current NZX shareholders did not elect to buy the new shares, these underwriters would do so.

The Chairman of the NZX then knew that all the current shareholders had been offered a fair opportunity and that the company was assured of receiving the additional funding.

Online application processes are now very simple and make good use of current technology.

I do have a suggestion to the investment bankers on this point; not everyone uses computers and there is another group of people who do not like doing so.

May I respectfully suggest to those investment bankers, and companies raising capital, that you pay a very modest brokerage fee for online applications and add a disclosure option so a financial adviser can declare that they have completed the application (record their FSP Number) with the permission of the registered owner.

Only a fool would put their Financial Service Provider registration at risk by completing applications without client knowledge.

There is also no risk to the asset leaving the legal name of the registered person, nor any payment offered reaching anyone other than the target entity.

So what happened to disrupt the NZX Rights offer and brought the underwriters into play?

Markets can, and do, encounter disruptions. Such disruptions are witnessed in the volatility of market prices. This is the reason underwrites (promises to pay) incur a fee; they are a form of insurance.

During the NZX Rights offer Vladimir Putin (as opposed to the Russian people) invaded Ukraine undermining investor confidence and placing more downward pressure on the NZX share price.

The announcement of the discounted Rights offer had seen the NZX share price decline a little (from $1.70 to $1.52) as some NZX shareholders played the game of selling about 1:9 of their current their holding, to then buy them back at $1.42.

Following Putin's invasion, the NZX share price fell to $1.42, the Rights offer price, and then spent the final week before the close of the Rights offer at about $1.38.

Market sentiment was weak enough to explain the $1.38 but I suspect there was also no way that an underwriter would buy NZX shares and pressure the share price back above $1.42 until they had received their new shares at that price.

After the close the NZX share price has begun a gradual rise in price again. There are two reasons:

The logical one – market sentiment has been a little better over the past week; and

The speculative one – the market has successfully extracted value from those who decided they did not want more NZX shares at $1.42 and they have not paid any premium at all for those additional shares.

Was the situation engineered?

No, although it won't stop the conspiracy theorists from believing it. However, armed with the set of circumstances presented the professional investors' behaviour was entirely logical.

The NZX reported that retail investors only took up one third of their entitlement for additional NZX shares.

At face value this seems logical when faced with an offer to buy more shares at $1.42 when the share price spent some of the time below that price.

I understand the math.

However, retail investors, for the most part, are not traders and certainly shouldn't be traders for a margin of only 2-3% on price movement. Investors are people who decide whether or not to own a business and should be indifferent to interim volatility in a share price.

Given that these investors had already decided that owning the NZX was something they wanted to do, another thought pattern could have been:

I own the business;

I like board strategy and management execution;

I have been asked to provide some additional financial support;

The potential rewards for the additional investment appear to justify the risk;

Do I have room within my asset allocation rules; and

Do I have some cash.

Whether the market price for NZX shares was $1.42, $1.38 or $1.50 shouldn't have made a lot of difference to the decision.

The NZX share price is now $1.44.

The NZX should be pleased with its new investment and its funding plan; it was fair and financially successful.

The NZX will be indifferent to the fact that its register of owners changed during the process because this happens on every day of every week as a result of share trading, which is of course the function of a stock market!

Wholesale – After explaining how busy the Financial Markets Authority (FMA) was in her first speech, the CEO Samantha Barrass then proceeded to say they were allocating some resources to look at the integrity of ''wholesale'' investment limitations.

That feels a little like me monitoring our staff use of power points at work.

There are legal definitions to abide by under 'worksafe' obligations. We have a Health and Safety policy. We discuss risks. We care. We employ mature people with a good sense of self responsibility.

The most recent evolution of financial markets law tightened the definitions of who can be considered to be a wholesale investor.

Since when did we begin defining people with millions of dollars in assets as financially vulnerable? (the term used in the recent speech).

Why is the regulator trying to place a responsibility on financial advisers for persons who are not clients of their business? The FMA describes a concern about the potential harm that may be caused to 'the client and their families'

My children are not clients of Chris Lee & Partners. I do not expect our financial advisers to consider the impact of my financial decisions against some speculative extrapolation to my boys, let alone our foster daughter who has no legal family connection.

A member of the public has the legal right to define themselves as a wholesale investor.

A financial adviser has the ability to reject a client claim that they wish to be considered as a wholesale investor. I have done this, and explained why to the person.

There is no magic behind the 'wholesale' wall.

Many investments are issued as 'wholesale' offers to minimise the regulatory impact for the offer, not to restrict access to high returns.

Spark issued a new bond last week to wholesale investors only. It was their first Sustainability Linked Bond (SLB) and with some strict monitoring obligations it was deemed to not meet the QFP Exemption for being issued quickly onto the NZX.

(From the NZX) The QFP Exemption is a prescribed exemption under clause 19 of Schedule 1 of the Financial Markets Conduct Act 2013 (FMC Act). It allows issuers with securities quoted on NZX's markets to make further offers of the same class of financial products, without meeting the full disclosure requirements in Part 3 of the FMC Act.

Therefore, the Spark bond offer needed its own new offer document and producing one to the standard required for retail investor participation was deemed a bridge too far and the offer became wholesale only.

Given the improved integrity being displayed by Spark (closely monitored use of funds) would financial advisers consider this bond as an increase in default risk for investors (clue – No!), more difficult terms and conditions? (same clue) or less return (same answer).

A few of these Spark bonds would have suited our retail clients nicely.

Maybe the FMA could ponder whether to review issuance restrictions or place a condition that applicants must confirm that they have received financial advice from a licensed provider?

Display some faith in the financial advice community and encourage self-responsibility obligations rather than displaying a lack of trust through ever tighter legislation that would need more policing.

Just a thought, from an ageing financial advisor with access to a public facing keyboard.

Money – Digital forms of payment are all around us, and the options will continue to expand such is their convenience, but physical money prevails, especially the US dollar outside of the US.

'Paper' money however is departing as fast as the cheque. Paper notes became easier to counterfeit evidenced by a rising proportion of such notes appearing back at central banks where they were disclosed by proper testing (0.10% in circulation).

Physical cash is becoming more plastic in manufacture. I'll bet this plastic doesn't reach the oceans or rubbish tips.

The thing that surprises me most about this story is that the general population seem to be wealthy enough not be focused on exchanging the old for the new. Are ''we'' really struggling financially if ''we'' can elect to not use old bank notes?

New Zealand wisely changed from paper to plastic years ago but using the UK example they are still waiting for £19 billion of £20 and £50 pound notes to be exchanged for the new plastic replacement item.

Maybe the majority of the notes are held by criminals but even they will need to exchange them before September, otherwise their only choice for exchange will be the banking framework where more data can be gathered about them!

You may have shrewdly deduced that this exercise in changing what is recognised as legal tender is also an exercise in combatting counterfeit and money laundering activities.

Think of that when you ponder if regulators will allow crypto currencies to replace fiat currencies.

AMPOL Criticism – AMPOL's behaviour during the takeover offer for Z Energy (ZEL) has not endeared them to ZEL shareholders.

Ampol paid their Australian registrar (Computershare) to call all ZEL shareholders to follow up participation in the Scheme of Arrangement vote. This deserves a tick for focus and effort.

However, they let themselves down badly by having Computershare pressure the ZEL shareholders unreasonably.

To ask if the ZEL shareholder had received the material, and to encourage them to vote would be good form, but they go on to ask how people will vote and to challenge any negative responses about the transaction.

Most people I have spoken with wisely rejected such interrogation, some hanging up on the callers when they persisted, and others viewed the calls as a scam given the style adopted.

The poor behaviour of the Computershare staff implies there was a financial incentive for converting people to vote, and quite possibly to vote yes, which makes them a lobbyist not an administrator.

What started out looking like effective administration finished up as a lobby group sounding like a scam (sadly).

Update: ZEL confirmed that the vote passed with >75% approving the scheme. Assuming the final regulatory hurdles are passed payment will be made to shareholders in May.

Ever The Optimist

There are many signs that the world is re-opening its borders, but it's excellent to read a local anecdote; Air New Zealand is accepting bookings to New York!

Investment Opportunities

Goodman Property GMT – through their vehicle GMT Bond Issuer Ltd is offering a new 5-year senior bond (maturing 14 April 2027).

Based on current market conditions the interest rate will need to exceed 4.50% p.a. to be competitive (credit margin details announced on Monday 4 April). Note interest payments are semi-annual.

The offer opens next Monday, and closes on Thursday, so requests for a firm allocation must be in by 5pm on Wednesday 6 April please.

Mercury Energy – We have established a deal list for those wishing to hear more about a new capital bond from Mercury Energy. We are expecting this bond issue to open over the next three months.

IAG Subordinated Notes – The IAG offer of $400 million subordinated bonds was completed last week and the interest rate was set at 5.32%

Thank you to all who participated in this bond offer through Chris Lee & Partners.

Clients are welcome to join these lists.

Travel

Johnny will be in Christchurch on Wednesday 20 April, seeing clients at the Russley Golf Club Boardroom.

Edward will be in Auckland on Thursday 28 April, seeing clients at the Ellerslie International, and on Friday 29 April seeing clients at Aristotles in Wairau Valley.

Edward will also be in Nelson on Thursday 12 May, seeing clients at Trailways Hotel, and in Blenheim on Friday 13 May, seeing clients at the Chateau Marlborough.

Edward will also be in Napier on 19 May and 20 May. Location TBC.

Chris will be in Auckland in 12 and 13 April.

 

 

 

Michael Warrington

---

Market News 21 March 2022

It feels like a very unusual time for a union to announce a strike relating to air crew, but that’s what E tu has done with Air NZ.

It will be hard to form an argument that Air NZ is benefiting financially under current business conditions.

INVESTMENT OPINION

General Ramble – Investors should already have reset their expectations toward lower returns after such a long period of high returns, but the invasion of Ukraine has added to the problem.

Then, investors who had been adding new ESG policies on their investment decisions and on the expectations of their fund managers will need to reset what they will tolerate.

I listened to an impressive historian recently who said that traversing the past 75 years with only moderate levels of war over borders has been highly unusual relative to history.

My favourite quote from him was: It is better to liberate ourselves from history than to be dragged down by it.

Putin has been dragged down by his own historical ideals.

The situation of relative global calm, until now, had seen significant reductions in defense spending and impressive increases in global cooperation and strategies for human centric improvements.

Productivity was increasing, poverty was declining.

Putin’s invasion of Ukraine to alter geographical borders shatters that period.

He logically predicts a new ongoing rise in defense spending, much of which will conflict with the ideals of ESG investment.

Ukranians will undoubtedly have shared our views for improving the planet and societal behaviours, but today they will happily invest in weapons and then use them.

To increase a country’s defense budget is to reduce spending elsewhere.

New Zealand is not a big player in the defense offering globally but we too must increase our spending, be part of a chosen team and we must look at the many questionable ways that we use public money.

We cannot simply increase spending, funded by more debt, to buy everything that we desire.

Following such a strategy is part of the reason the world’s public debt levels are so high. It is beginning to look like the day of reckoning that many commentators speak of is here, or very close.

Nations are already holding back Russian reserves in foreign currencies. Russia is retaliating with more bullets and refusals to meet financial obligations (debt defaults) and nationalizing other peoples’ property.

Tit for tat behaviour is destructive, and destroying value, which is the last thing the world needed when it was more dependent on success at the margin given the very high levels of operational tension that the global system was operating at.

The high levels of global debt accumulated need high levels of marginal economic performance and that will not be the outcome now, in my opinion.

Putin will not respond to this new financial pressure by withdrawing his war machine. Therefore, financial defaults are inevitable.

I cannot yet tell who else will default on financial obligations, by choice or by an inability to pay, but it does appear to me that lenders (global average) will suffer a lot in the next 3-5 years through inflation (loss of present value) and defaults (failure to repay).

You should have much lower concerns about this statement if your fixed interest investing is restricted to New Zealand entities.

You can consider our government and local government to be at nil risk of default.

You can consider SOE’s, banks and essential businesses in New Zealand to be close to a nil chance of default.

Asset Plus shareholders will be disappointed with the company’s decision to suspend its fourth quarter dividend, with APL’s Board citing ongoing Covid 19 pandemic tenant uncertainties as the major reason.

Yes, some businesses will feel a need to be conservative, and investors shouldn’t be expecting rising dividends (on average) but businesses that are well run shouldn’t need to make many changes.

There will be an investment dichotomy that ESG focused investors will find frustrating:

Two sectors that seem likely to be profitable following Putin’s invasion are renewable energy (ESG tick) to replace Russia oil and gas and weapons (ESG cross)!

The extraordinary period of relatively smooth sailing for investors (calm declining interest rates and rising share values) is over. We can no longer choose to sit on the general (or ESG) conveyer belt, we need to be more selective and more careful about our choices.

Try to avoid holding on to investment ideals that were based on risks and assumptions from the past decade.

Oil – Here’s a story that should remind advisers and investors to avoid making stark black and white forecasts:

‘Modern’ investment hero Cathy Wood of ARK investments, who loves technology, predicted (in 2020) the demise of oil and a price of US$12 per barrel.

Oil demand probably hit a secular peak last year (2019) and, thanks to electric vehicles, now is in secular 'decline.'

I’ll bet she cringes about how easily it has reached a price of US$120 (10x increase).

A common response to such a mistake is to extend the time frame of the prediction, which Cathie Wood has done, by adding supplementary wording:

I still expect prices to crash under the weight of lower demand.

I ‘still’ think she is correct about a slow evolution of energy use toward renewables, but it was unwise to make predictions about future pricing to reinforce that opinion.

Invest where you think the best returns will be found, just don’t make predictions about precise returns or future prices.

For fun – Warren Buffett has recently increased his investment exposure to the oil industry. He is showing you; Cathie Wood is telling you.

Battery – I don’t think this news will arrive fast enough to counter the removal of Russia’s energy supplies, but in time it will help. The ability to store renewable electricity at an economic price will be an important part of reducing our use of fossil fuels and their desirable quality of being portable energy.

Until this point batteries were uneconomic to buy and add to the electricity network for most users, but an oil price of US$125 per barrel and a refusal to use Russian supply surely changes the economics!

Battery innovations continue and are now a very busy part of the renewable energy frontier. There are many super chemistry and physics brains at work in this field.

The latest item that I read describes another new battery technology that has extended the potential distance of a vehicle based solely on a battery swap – The test case was a Tesla S where the range increased from 480km to 800km+.

The previous battery news item I drew to your attention to related to carbon nano tubes as the energy store, with rapid charge characteristics.

This item relates to battery technology being developed by US start up ‘Our Next Energy (ONE)’; being a ‘dual battery’ product to include the safety of Lithium-Iron-Phosphate product (‘Aries’) linked to what they call a dual-chemistry product (‘Gemini’) where their secretive patents (13) lie.

They say their new batteries are safer than the Nickel-Cobalt-Aluminium (NCA) alternatives (used by Tesla) as they avoid Thermal Runaway (I had to read about this!) and extend the range (energy available).

Wikipedia describes thermal runaway as: a process that is accelerated by increased temperature, in turn releasing energy that further increases temperature.

This will be what leads to the car fires reported from time to time, and I suspect you have all experienced it with your cell phones when their heat rises to your surprise (turn it off).

Their ONE battery and supporting technology will be ready for prototype use in 2023.

I have saved the magazine article if physics and/or chemistry enthusiasts are interested in reading it (short article).

The investment thesis for you is - Investment in renewable electricity generation has a robust future.

In the meantime, sadly, Putin has driven the world to buy far more coal to ensure they have a ‘battery’ of energy stored. At least our neighbour and significant trading partner (Australia) is benefitting from this short-term disruption.

Kevin Writes:

Economists attract a lot of media attention in NZ and have quite a big influence on retail investors.

Late last year you might recall a young economist called the Reserve Bank Governor ‘‘spineless’’ for only increasing the OCR by 0.25% when he believed a 0.50% increase was appropriate.

Last week the same young economist was back in the media painting a grim outlook for the NZ economy as events here and overseas push consumer confidence to an all-time low.

He then cited some of the concerns that maybe the older, wiser head on the RBNZ Governor may have held at the time of his OCR decision.

I’ve always regarded people making big, bold predictions as attention seekers so I try to avoid doing it myself although I do have some quite hardened views on interest rates, which in my opinion is the key ingredient for most investment decisions.

Only time will tell whether I’m correct, but I am increasingly convinced that despite record high inflation, which looks like hanging around, interest rates won’t run as high as many market commentators believe.

The OCR rising to around 3% is already factored into wholesale interest rates so with the OCR currently 1% all that is left is for the RBNZ Governor to actually deliver the increases over the next 12 – 24 months.

The OCR influences interest rates out to approximately two years so it is already built into 1- and 2-year fixed mortgage rates which have roughly doubled over the past 12 months and now sit between 3.80% - 4.40%.

The banks will probably try and take a second bite as the RBNZ actually nudges the OCR up, but I can’t see 1- and 2-year fixed rates rising much above 5%.

The yield curve beyond 2 years is quite flat (but not yet inverted) so mortgage borrowers who spread their risk between say 1 – 5 years should still be able to achieve an average rate of around 5% which should be manageable for most (if I’m correct).

Similarly corporate bond yields have increased from low 2s 18 months ago to low 4s now. Senior bonds from Genesis (4.17%) and SBS Bank (4.32%) recent examples.

Like mortgage rates I think senior bonds could reach about 5%.

I realise that when inflation is a problem we always increase rates to bring it under control but I see a constrained response from the RBNZ this time round, and other central banks for that matter, as it tries to balance high inflation, high debt levels and declining economic growth.

The NZ economy is showing signs of slowing and the big domestic spend we witnessed after our lockdowns in 2020 seems unlikely to be repeated.

Certainly, tourists will return soon but will their numbers be big enough and soon enough to make a meaningful difference this year?

Living costs for large ticket non-discretionary items – food, fuel, energy, rent, rates, insurance – have skyrocketed while wage inflation has been moderate (less than 3% increase for 80% of New Zealanders in the past 12 months) leaving many households struggling and with significantly less discretionary spending power.

Consumer spending represent 65% of the NZ economy

Also, we shouldn’t underestimate the impact mortgage rate increases have had already. Every 25 basis point rate increase costs the average mortgage holder an extra $825 per year and with 1 and 2 year terms the most popular for fixed rate borrowers most will soon have to face up to the new rates.

Figures also show that 48% of household income is now required to service an 80% LVR mortgage (25-year term), based on the average property value, up from 33% in 2020.

Commentary around increases to interest rates usually focusses on the housing market but when rates go up everyone pays extra including businesses and farmers.

Our farmers seem to be doing OK but the same can’t be said for many businesses who are suffering from lockdowns, no tourists, no customers, supply disruptions, higher operating costs, and more.

Over 5,000 Auckland businesses impacted by Covid have received Government support packages in the past 3 months and Insolvency experts believe economic conditions are ideal for a large increase in the number of insolvencies.

Hardly the climate for aggressive interest rate increases to fight inflation. Also, we are importing inflation and it is largely supply driven, not demand driven which can signal a growing and healthy economy.

With the Government providing cost of living relief initiatives it is very hard to imagine the RBNZ turning the screw too aggressively on interest rates.

If anyone needed convincing about the current fragility of the NZ economy electronic card transactions were down a whopping 7.6% in February, described as a very ugly number by economists.

For at least the last 6 years I have listened to economists banging on about higher interest rates and lower house prices. I’m still waiting.

Certainly, house price growth has slowed recently and maybe prices will come down 5% or a bit more or just go sideways for a while. Most house prices have risen 15% - 20% in the past 12 – 18 months and doubled in the past 5 or 6 years so giving a bit back is hardly catastrophic.

Also, as a very successful retired builder reminded me last week house prices are largely driven by the cost of a section and the cost of building a house on it. Are section prices and building costs coming down?

So, if you’re in the camp of only modest and manageable increases to interest rates and no big collapse in property prices what sectors and stocks look oversold?

The retirement sector has taken a big dip, as have some interest rate sensitive dividend stocks.

Even though the NZ sharemarket has retreated 10% or more this year overall it still looks expensive on a technical basis, particularly ultra- growth stocks.

Higher interest rates reduce the present value of future cash flows and drag market valuations down.

The sharemarket always seems to overshoot, both high and low, particularly if interest rates don’t do what market expects.

Picking the bottom is always difficult but some excellent buying opportunities seem likely to be present during the year.

Investment Opportunities

IAG Subordinated Notes

The IAG Subordinated Note Offer opens today.

IAG has announced an indicative margin which implies an interest rate above 5.00%.

New investors wanting to join our list for the Primary Offer should do so before 10am, Friday 25 March. Please nominate your firm allocation requirements.

Holders of the 2016 IAGFB Notes, which mature in June 2022, can now apply through the Direct Re-investment Offer. This Offer is on a first-come, first- served basis so we recommend that those who have elected to re-invest should act promptly. IAG are only allowing $30m of the $350m to roll-over so if you plan to roll your investment back into the new IAG notes we strongly recommend doing this urgently.

The website to roll your existing IAG investment can be found on the link below:

https://www.iagsubordinatednotes2022.co.nz/

We would appreciate if you selected ‘Chris Lee & Partners’ as your broker on the roll-over application form. Thank you.

Mercury Energy – We have established a deal list for those wishing to hear more about a new capital bond from Mercury Energy. We are expecting this bond issue to open over the next three months.

Clients are welcome to join this list.

Chris Lee and Partners Ltd

---

Market News 14 March 2022

The steep increases in the global cost of energy and food do not bode well for global poverty and health outcomes.

INVESTMENT OPINION

 

Russia – Both Chris and I have spoken in newsletters about a fellow by the name of Bill Browder.

He wrote a revealing book in 2015 called Red Notice – How I Became Putin’s No.1 Enemy.

Browder made a variety of observations and seven years later the book is even more relevant because of its prophetic accuracy.

Browder is still lobbying governments around the world to help by passing a ‘Magnitsky Law’ in every country that will listen.

The expectation of the law is that countries will be authorised to seize assets from human rights offenders and ban those people from entering their country.

In 2016 the US was one of the first to enact such law.

New Zealand is still thinking about it, but the situation in Ukraine has brought the matter back to the fore. Last week our parliament was re-energised into supporting the proposed law.

The name used by Browder for the law is in reference to Sergei Magnitsky, Browder’s lawyer in Russia who, after revealing fraud by people at the top in Russia, was detained without charge, tortured, killed and absurdly was found guilty after his death.

The US list of named offenders under their Magnitsky law started with 18 people but has now expanded to about 90 and given the unravelling of political behaviour globally it is on a constant growth trajectory.

In my view all reasonable countries should be joining this network and making movement difficult for criminals.

It was all too easy to install the Anti Money Laundering law and delegate huge policing responsibilities upon us so it would be nice if central governments played their part in restricting the movements and finances of known criminals too.

Even though the US dollar is the dominant global currency it is important that all other currencies play a role in restricting the movements of politically linked criminals. The criminals all want to hide money and assets outside the countries they are pillaging (in case they need a rushed escape), and the US dollar is the most widely accepted money on the planet.

I wouldn’t want to hold bonds issued by the Russian government, and perhaps many businesses controlled by the oligarchs. I’ve seen them default in 1998 and effectively call the world’s bluff.

At that stage in the economic cycle the world was trying to coax Russia further into deeper economic relationships with other nations.

The circumstances are rather different now!

If Russia is willing to shoot at you, you can be sure they wouldn’t even blink before deciding not to meet their financial obligations to you.

POSTSCRIPT: Russia has already announced that it will stop paying interest on bonds held by foreign investors and proposes to nationalise assets of businesses that remove services (such as Shell exiting fuel distribution in Russia, and Toyota, McDonalds, Nike and IKEA suspending operations).

There are some very big financial levers being pulled in very short time frames, by governments and globally influential businesses.

You know my view about large changes over short time frames; the public does not cope well.

The current financial tsunami(s) will be felt well into 2023 in my opinion, and then even if progress is made on settling the war in Ukraine I think the next 5 to 10 years will be badly strained politically and financially.

Global trade, and settling global disagreements will be much more difficult.

The only positive I see for the political landscape is that maybe the current need for togetherness will dilute some of the extreme left versus right behaviours we had been experiencing.

I find myself wondering how Mikhail Gorbachev (91 years) is viewing this latest development. It was he who led the Soviet Union toward a more socialist democratic approach with more freedoms (without bullets being fired).

Today’s political disruption is a function of fewer freedoms and seems to be linked to the old Soviet era as Putin tries to reverse changes that disrupt his reminiscent dreams.

As I said last week, if China truly wants to gain the respect of the world in its competition with the US, it too needs to introduce its own Magnitsky Act and show us all it takes the matter seriously.

China’s initial steps have been more selfish than global.

If the world wishes to avoid using bullets in support of Ukraine, ‘we’ must tighten a collective net in every other possible way to restrict the choices of those who have offended ‘us’ so much.

The impotence of the United Nations, born out of the last major war in Europe, may well undermine its future relevance.

We behave this way locally. We don’t shoot offenders; we restrict their options and movements.

If you are friendly with a local Member of Parliament, encourage them to read Red Notice and then to also think about the Jamal Khashoggi murder, and Felix Bautista and Myanmar’s generals, on a very long list of people who would rightly be affected by such a law.

Post Script: NZ passed a new Russian Sanctions law, and named 100 related persons (US supplied no doubt). I hope it is written to cover off non-Russian misbehaviour.

Oil and Gas – A consequence of the Russian invasion, and the sharp increases in energy prices, is some greater economic benefit to Australia.

Australia is a country blessed with natural resources in large quantities and a regulatory framework for mining and export.

Meanwhile in New Zealand, the perverse consequence is that the war is driving up our government’s revenue through the 50% tax collected from the price that we pay for fuel.

Good leadership is commendable, including environmental objectives, however New Zealand’s ban on oil and gas mining did not attract global followers and is now costing very large sums as we import the energy required.

I hope that the higher fuel prices accelerate uptake of hybrid and electric vehicles and that we increase our investment in renewable electricity in New Zealand to further reduce our reliance on international energy supply and pricing.

How about Cabinet approaches each of the government’s electricity companies (51% owners of Genesis, Meridian and Mercury) and advises them that the government will underwrite new capital and debt funding used to finance new projects that increase renewable generation.

Thereafter, rather than building the illogical Lake Onslow battery project, the government could underwrite a minimum electricity price to support the new long term generation units (but not old fossil fuel-based generators).

The electricity market knows when each generation unit is being used and for how long, so the financials would not be hard to measure.

Assured funding and minimum revenue would set directors and chief executives onto the expansion pathway in short order.

As I have said many times, I’d rather Rio Tinto (Tiwai smelter) left town, but if it acknowledges its economic need to remain here then it must pay the market price for electricity, no subsidies.

President Reagan is credited with saying: If you want more of something subsidise it, if you want less tax it.

With Rio Tinto we can change levers; remove the subsidy completely and then add in the carbon tax.

Putin’s actions should result in a willingness to make good decisions quickly and to remove all nonsensical actions that bring us no good.

AGL versus ESG – Here’s another story that challenges one’s beliefs about the world’s willingness, and capacity, to gradually reduce fossil fuels and to increase renewables.

Giant Australian energy business, AGL (Australia Gas Light Co.) was under a takeover offer from a very wealthy individual (Mike Cannon-Brookes) and an international fund manager (Brookfields) armed with a strategy of accelerating AGL’s withdrawal from fossil fuels (15 years faster) and a move toward more renewables.

AGL directors rejected the offer, and thus the strategy.

Instead AGL directors plan to separate the ‘good’ and ‘bad’ generation assets and presumably will use terms such as optimise and maximise for their future (financial) strategy.

Corporations law will make it very difficult for a director of a coal generation asset to simply shut it down, because of obligations to shareholders.

It is presumably for that reason that Cannon-Brookes was offering to take the business private and thus be able to retire the bad assets to an aggressive schedule.

He might have subsequently relisted the ‘good’ generation assets back onto the ASX.

AGL directors are left looking rather blinkered in my opinion.

The Age described it well as the directors chose ‘cash green’ over ‘environmental green’.

Non-Bank Funding – The tightening of lending policies by the banks and the difficulties created by adjustments to the Credit Contracts and Consumer Finance Act do not mean borrowers’ needs have gone away.

Other non-bank lenders have been quickly boosting their scale to lend more, and many of those businesses are now approaching the public to invite investment in their vehicles or project specific funding opportunities.

There is likely to be some propositions that present genuine marginal value to investors for the additional risks (lending that banks are willing to let go of) but those investors would be very wise to seek financial advice before making their decisions.

Some opportunities that I have seen do not offer sufficient additional reward for the risk.

Some schemes come with very comfortable risk-free fees (up front and annual) being paid to the businesses offering and managing them.

I really would like to see the non-bank funding sector expand, but it can only succeed if the risk and reward situations balance well and this can only be measured with good financial advice.

Ever The Optimist

To offer a strand of optimism for the United Nations, they coordinated a successful meeting in Kenya and 175 countries agreed to establish a committee for designing a legally binding treaty to tackle the proliferation of plastics.

Russia and Ukraine sent delegates, which was initially awkward until many other delegates started attending sessions dressed in yellow and blue clothing!

Every little bit helps.

Investment Opportunities

IAG Insurance – has announced that it plans to issue up to $400m worth of subordinated notes. The interest rate has not been set yet; however, we anticipate that the notes will offer at least 5.00% which will be fixed until 15 June 2028.

Full details on the offer, including a presentation, can be found on our website. Kevin is writing an article on this offer for advised clients only which we will upload to the private area of our website from tomorrow morning.

IAG have confirmed that they will pay the brokerage cost for these notes. Accordingly, clients will not be charged brokerage.

 

SBS Bank – has successfully issued $150 million of its new 5-year senior bond. The interest rate was set at 4.32%.

Thank you to all who participated in this offer through Chris Lee & Partners.

Mercury Energy – We have established a deal list for those wishing to hear more about a new capital bond from Mercury Energy, once it is offered.

Clients are welcome to join this list.

Travel

There are no client visits planned at the moment.

Michael Warrington

---

Market News 7 March 2022

An NBR headline hit the point for me:

Ukrainians' want to move forward; Putin wants to move backward.

As insurers will tell you, moving in reverse is a much higher risk.

INVESTMENT OPINION

 

Russia – The financial market reactions following the invasion of Ukraine remind investors about the largest economic influences in the world and it's not Bitcoin or Non-Fungible Tokens.

Look at the price of energy, including the dastardly fossil fuels – oil has jumped to USD$115 a barrel after longer term averages were recently $50-$65;

Look at the behaviour of the US dollar, especially relative to the Euro or (good grief the Russian Ruble) attracting investor capital to the USD;

When the US dollar rises in value the price of gold usually declines, but it is higher at present;

Look at the 10-year US Treasury yield, once rising because surely this was a one way bet and inflation is too high – The yield has fallen from 2.00% to 1.75% in a week;

The US share market had already lost some of its prior confidence and whilst the reaction to the situation in Ukraine is muted, it will in my view continue to lose confidence in economic outcomes as the fighting continues.

Doing business is hardly likely to become cheaper or easier now that we have layered a war on top of the already Covid disrupted global logistics.

At this stage the world has been reluctant to join in with the shooting (a relief) and has been making a commendable effort to restrict Russian economic activity.

The most powerful action that I read about was to remove access to the globally important SWIFT service for international banking. Imagine if you were told you could not access the New Zealand banking framework; this should help you to understand the scale of this action.

I hope Europe expands their next most powerful action and begins to remove Russian supplied energy from its economies.

It will take time and will be financially painful, but if 'we' were willing to spend vast sums on pandemic health outcomes, surely we will do the same as a passive tool of war.

Nuclear energy was unloved over recent years, but well managed nuclear power is unquestionably better than poorly managed politics.

Egotistical dictators and autocrats aside, political leadership is supposed to be about the people and whilst the public rising up hasn't worked in my lifetime I am hoping that the internet, and our global reliance on it, will help this time and stunt the effectiveness of the Russian invasion.

1789 might give historians hope.

China has some big decisions to make.

If China truly wants to continue its path to being a dominant global power, respected by the majority, then in my view it needs to confront Russia and reject its actions in Ukraine.

I am certain that financial markets are expecting China to silently side with Russia because of the energy and food supply situation between the two, but China could truly alter world order and influence if they do the opposite.

Is it possible that social media and computer networks will prove to be more powerful than tanks and guns?

Is it possible that hackers could reach inside modern tanks and influence their functions?

Apparently 175,000 tech experts globally have answered Ukraine's call for assistance to disrupt Russia via internet-based attacks. Even war can be fought remotely in Covid times!

Putin's downfall may not actually happen, but it is the only way this latest conflict ends in the way we all hope (restoration of Ukraine's independent government and borders).

The only message of any use to you, the New Zealand investor, during this invasion and political aggression is to reduce your risk profile, simplify your investment activities, increase cash holdings and be sure that you are in control of your financial destiny regardless of how market pricing plays out.

Energy – Directly related to the paragraph above:

Just as the world has been addressing how to evolve its energy consumption, and in Germany's case the preference to remove nuclear power, Russia has forced updates to the decision making.

Europe is a consumer of energy from Russia and they had been agreeing to increase the consumption volumes of gas (Nord Stream 2).

Russia's invasion of Ukraine saw an initial response from Germany of freezing the Nord Stream 2 gas project. Frankly I hope they cancel it and write off the investment.

Nord Stream 2 delivers gas to Europe without crossing Ukraine. This is clearly a risk reduction strategy by Russia, where they may have assumed threats could be made to the integrity of the pipes that cross Ukraine.

If the world prefers not to shoot bullets (nice ideal) then economics is all they have left to apply pressure.

If Europeans can reduce their energy consumption, they gain two benefits; push back against Russia by buying less gas and reduce the carbon related harm to the planet.

Europe also needs to immediately contemplate self sufficiency in energy (They could contact Infratil's Galileo business for assistance – Ed.)

Germany will be forced to review its decision to exit nuclear power as an energy source. I always wondered what the famous ''son of Germany'' (Albert Einstein) thought about the departure from nuclear energy for the country.

However they might achieve it, Europe now needs to make new efforts to towards energy self-sufficiency and avoid being beholden to supply from countries exercising unacceptable political behaviour(s).

Perhaps the UK could rapidly expand its energy generation capacity and position itself to supply Europe, and thus settle down the angst between the two post Brexit?

Nice thought.

One thing is clear, Europe has some very big decisions to make regarding energy generation and consumption for the future.

ESG – Is founded in nicely defined ideals, but as you are being reminded, investment risks change, and we must respond. (Russia!!)

The world was making some good progress on climate improvement matters, where energy consumption and energy types were critical to outcomes, however, ESG has very quickly lost its priority position whilst we tackle the Russian invasion.

Investors should still demand an ESG focus, improved measurement and reporting from directors of investee companies but we will need to cut some of them some slack with hitting their targets during 2022 and 2023.

Financial Advice Services – Last week the Financial Markets Authority censured a business that provides access to derivatives for the public.

I found myself uncomfortable with the censure because the FMA expected the clients of the business to demonstrate skill with the derivative, otherwise the business should reject the client relationship.

What is the purpose of a financial adviser under this judgement?

We have just spent 10 years designing regulations to improve the provision of financial advice to the public.

Surely we should now expect the public to engage in financial advice if they are confronted by a financial risk that they do not understand.

To be consistent the FMA should now censure all broking firms because our clients are absolutely not skilled, nor expert, with investment in bonds, units or shares.

My kids have Sharesies accounts, and I am quite certain they are not skilled, nor expert, in the use of share trading accounts!

As you parents will understand, don't be thinking the kids listen to me on the subject.

Sharesies has very clearly added value to the New Zealand savings and investment scene, it is broadening participation in financial markets and has increased the knowledge base of our younger generation.

They are a positive influence, yet they would seem to breach the same client suitability check that the FMA has tagged the derivative provider with.

The censured business offered a product called Contracts For Differences (CFD), where an investor (or business) could accept a financial exposure which would win or lose based on the difference between today's price and the price on a future date.

CFD's are relatively straight forward to understand and use; especially when financial advice is provided.

In an interesting irony, that the ideal users of derivatives, such as CFD's, would be those least likely to understand them.

This is because the derivative user should be too busy focusing on what they are good at, say running a dairy farm (milk being my product focus for this example), and not studying the complexities of derivatives to become a skilled practitioner.

If a dairy famer knows the volumes of milk he/she is producing, and they would benefit from accessing sales at a certain price on a future date (say $9.75 per KgMS in May 2022), then today the farmer can use derivatives to try and complete such a sale.

It's not hard.

Unless that farmer has more intellectual capacity than most of us, they would be wise to engage with a financial adviser to guide their use of financial products within their overall financial management strategy.

They rely on their bankers, lawyers, accountants, land advisers and livestock advisers so using a financial adviser for financial risks is the same concept.

What the dairy farmer does not need is the regulator insisting that they become skilled in the use of financial market derivatives any more than they should be skilled in banking, legal matters, accounting etc.

Can you imagine a legal firm such as Dentons Kensington Swan explaining to a famer that they could not accept his business because he was unable to display a skilled knowledge of the immigration and employment law as it relates to Recognised Seasonal Employees?

Here's a real-life example:

I met a very successful dairy farmer last year whilst in Te Anau. He and I debated the use of CFD's and Futures Contracts for his business. He was not skilled in these products but he knew he should be making use of them.

He was generously and passionately trying to help Te Anau through its current economic difficulties. He is the proud new owner of Fiordland Jet (a must do in the town) but I doubt Maritime NZ blocked him buying the business because he could 'drive a cow but not a boat'.

Look, I wouldn't want the FMA's job for all the tea in China and Sri Lanka combined, but I think they have done themselves a disservice on this item and might reflect on the risk of reducing the availability of good service options to the public, which wouldn't be a good outcome.

The glaringly obvious, and biased, conclusion is to engage in financial advice when taking financial risks.

Covid News – I know I said I'd avoid this subject in 2022, but I took some relief from reading this article (link below).

If you feared becoming a pin cushion forever, data is building that may prove this is not the case.

https://www-nytimes-com.cdn.ampproject.org/c/s/www.nytimes.com/2022/02/21/health/covid-vaccine-antibodies-t-cells.amp.html

One certainty with Covid is that there is a rapidly growing mountain of data, and given the world's willingness to store massive volumes of data (hat tip Infratil) we will be able to analyse it to the nth degree every month!

However, I shall not be doing so.

Ever The Optimist

Is anyone offering odds on milk reaching $10 per KgMS?

Boy, does New Zealand need this story right now.

If you hugged a farmer last month, do it again this month.

Investment Opportunities

SBS Bank – Tomorrow SBS launches its offer of $150 million 5-year (18 March 2027) senior bonds (NZX code SBS010).

They will estimate the interest rate tomorrow and set the actual rate after the close on Friday.

As I write, the interest rate on the SBS bond should exceed 4.00%.

SBS is one of New Zealand's admirable smaller banks, but the interest rate offered should be a little higher than could be achieved by the larger banks with 'AA' credit ratings.

Interest will be paid quarterly on this bond.

SBS is paying the brokerage costs on this issue.

Clients interested in investing in this bond should contact us now (prior to Thursday p.m.) to express a firm amount.

Genesis Energy – successfully issued $125 million senior bonds last week, with a 6-year term, at an interest rate of 4.17%

Thank you to all investors who participated in this bond offer through Chris Lee & Partners.

Mercury Energy – The half year results announcement included a disclosure that it is considering offering a new subordinated Capital Bond during the second half of the financial year (which ends 30 June 2022).

For preparation, you may recall the details of Mercury Energy's other Capital bond (MCY020):

A 30-year legal life (to 2049), 5-year initial fixed rate period (2024) then possibly retained until 2029 but I suspect the corporate preference is to redeem and reissue the investment so as to retain the ongoing equity recognition available to the company by ensuring that residual life is always greater than 20 years.

With the returns on senior bonds rising to 4.00%, and a little above, the return on a Capital Bond should really be knocking on 5.00% returns now.

Let's see what happens.

Travel

Chris is in Auckland on March 14 – 16 and has three available times to meet investors at Mt Wellington on Tuesday March 15 (2:30, 3:15, 4:00)

Michael Warrington

---