Market News 26 October 2020

The government hadn't even heard the election results and they signed a deal allowing local businesses to access facial recognition technology.

A good thing?

I happen to think so because it makes my own technology use easier, but George Orwell would be turning in his Wellington grave, happy to be exhumed and declare 'I told you so!'

Side story – Infratil investors should be pleased; just think of the volumes of data captured that will need to be stored securely.

INVESTMENT OPINION

Election – There you have it; we begin another three year cycle of government and as I write it looks like a Labour alone government.

I think I managed to avoid discussing politics in the lead up to the election, yes?

I certainly commented that investors shouldn't focus too much on the election, nor change their portfolios in the lead up because both sides of the house are relatively moderate and won’t be too disruptive to our nation’s progress.

Global economic struggles and Covid19 are having far more influence on New Zealand than whether we are being led by the blue or red team.

I am curious to learn whether NZ First and the Green party were moderating forces for the previous period of government or whether they (MMP) stymied the potential for more assertive governance.

Without wanting to debate themes, the previous term of government was not one of delivery, as promised; for the term ahead there should be no excuses.

We’ll find out over the next three years.

I dislike financial waste, which regulators are prone to, however, if used well, the very low cost of money for the years ahead of us should enable NZ to achieve some quite impressive infrastructure progress, benefiting all for many years.

I hope the government now spends more time on introducing long term evolution for our tax collection. I think the increase to the top tax income bracket was simply politics at work and won't help the nation.

Far better that they discover new broad and shallow taxes that raise far more money (I'm still thinking about land tax as I say that) and then design neutralisers for low income people (lower personal tax rates) and for desirable businesses (productive land use and exporters especially).

There are people far cleverer than me on tax collection who can design good methods but I still subscribe to the 2009 Tax Working Groups recommendations, which included a land tax. Given our nations propensity for ploughing excessive sums into this often unproductive asset type introducing a broad based tax should prove effective with several objectives.

Dreams are free I guess. Government policy adopted from Market News hasn't been all that common over the past three years.

There is also surely a chance that the increased local spend (you can't travel) and the high volume of people trying to return, or emigrate, to New Zealand should give us an excellent opportunity to make better economic progress than many other nations who are still squabbling around the world.

There are plenty of things to be concerned about but I am a glass half full person so I am optimistic that our government will improve New Zealand's lot over the next three years.

Why wouldn't they?

They want what you want. (for the most part – Ed)

Even if one disagrees with the process the objectives are the same and tail winds are running (low interest rates, population expansion) so it's hard to see why we can't be collectively better off by 2023.

Now, who is up for some fruit picking?

Investment Behaviour– For a while it seemed logical that the Covid19 disruption we see investors pursue a lower risk investment strategy of reducing exposure to property and shares, increasing their fixed interest investing, but other than for the month of March 2020 the opposite has been happening.

It's become a reward race for investors and 0.00% is suffocating.

A recent article about the world's largest fund manager, BlackRock, continues to confirm that Exchange Traded Fund use is showing that they are the investment vehicle for all seasons, growing in scale through upswings, downturns, optimism and fear.

Over recent months the funds offering higher risk settings are attracting the most money.

Funds under management at BlackRock have increased during the Covid19 pandemic rising to US$7.8 Trillion. $2.3 Trillion was in iShares ETF’s and of this 70% was allocated to shares risks.

You'll often read about the 60:40 rule for asset allocation in the US (60% shares/property and 40% fixed interest), which until now I had always thought of as ambitious but investor behaviour is pushing the risk dial higher even in the face of all Covis19 related economic threats and 0.00% interest rates.

Low fees, huge diversity and ocean deep liquidity for most ETF funds is attracting investors who realise that market returns no longer support higher fees on other fund structures.

More reward lies in property and shares investing but so too does greater volatility (remember March this year?), so 70% across these two asset classes looks high to me (only 30% in fixed interest) but BlackRock chief Larry Fink says that investors need be even more aggressive yet!

With interest rates so close to 0.00% out to very long terms Fink says 'There's no question ... government bonds are going to play less and less of a role for most retirement portfolios'. 'You certainly would not use government bonds for income purposes.’

Fink is very concerned about the lack of superannuation savings in the US to support those who wish to retire from employment and he knows todays 0.00% interest rates accentuate the problem and make its effect immediate. It is no longer a problem that they can kick down the road.

Fixed interest investing is fast becoming only a stabilising force for the volatility of a portfolio and access to capital in each calendar year but little else.

Fixed Interest investments in a portfolio should provide an investor with financial progress (diversity) when all else was falling in value. When economies and share prices struggle interest rates usually fall, increasing the value of fixed interest investments.

The scope for such gains from fixed interest investing is now proportionately compressed and thus is not offering the same investor protection (diversity) that it did in the past.

In the past an aggressive fixed interest investor could also borrow short term, to invest in long term fixed interest assets and double the 'protection' offered by the fixed interest investing (holding a double helping of long term bonds) and receive a positive income from the strategy whilst watching out for economic distress, which would drive up the value of the fixed interest investing too.

Borrowing money at near 0.00% to invest at near 0.00% doesn't hold the same potential to double up on the protection!

The benefits of leverage and convexity (rate of price change for a long term fixed interest investment) are negligible so no longer offer the anticipated diversity to an investor's portfolio.

I apologise, I became a little complex there; it is a long hand way of saying that fixed interest investing now really only brings stability to your portfolio and little or no prospect of a marginal increase in wealth as an offset to investment losses in property and shares. Diversity yes, but negative correlation not really.

Any good news? – Ed

Yes, the cost of capital for running a business has declined, which stands a chance of increasing net profits for good businesses.

If you happen to be interested in a deeper, technical, explanation about the art of diversity via fixed interest investing take a look at this article from an expert, Ben Alexander (plus research team), who is yet another person I enjoyed working with in the past. Ben was a co-founder of this specialist fixed interest investment fund in Australia (Ardea).

https://www.ardea.com.au/does-duration-still-diversify-equity-risk/

The term 'duration' relates to investment in bonds with longer terms until maturity. The longer the bond, typically the higher the yield and the greater the potential for a change in value of the bond if market conditions move.

If nothing else, you'll hopefully conclude there's value in engaging with a financial adviser!

Proxy Voting – Regular readers will recall us urging retail investors to assign their voting rights to the NZ Shareholders Association as a Standing Proxy. The NZSA considers the issues and exercises your vote at meetings.

We still encourage you to do this (we have the forms available) to make sure your votes have influence.

I am writing this paragraph to happily record that we are beginning to see NZSA's influence at meetings rise because they are drawing out criticisms from those they are voting against.

The recent critic happens to be a director I quite like, Rob Campbell.

Typically votes against director nominations fall well below 5% of the count but two weeks ago 16.76% voted against Rob's re-election as a director.

Rob expressed his disappointment in this outcome labelling proxy voters as lazy, simply voting on a principle of 'too long on the board' or 'stands on too many boards' and not a qualitative assessment of his input.

Mind you, Rob, 83% support is pretty good result following a more robust voting process than we have experienced over years past.

Rob logically defends the qualitative aspect of his presence on boards, as he should.

The NZSA defends its voting position based on certain meritorious principles, in this case excessive tenure or stretching one's capacity too thinly across too many boards.

Both perspectives are valid and thus should engender a healthy debate, following which a vote occurs.

As I say, Rob received 83% support.

Everyone, including Rob, should be energised by the rising volumes of voter participation at meetings.

Retail investors should be pleased by the rising influence of proxy voting because the majority of these votes presented no influence in the past. Now some do.

If you haven't yet provided your Standing Proxy to the NZSA we encourage you to do so. Please contact us if you'd like us to email you the forms to use.

Rob, congratulations on re-election and for taking the opportunity to remind investors of the value you bring to a board of directors.

Rural Land – For all the years I can remember, capital markets people have tried to create opportunities for the public to invest in rural land without needing to own a whole farm, or actually do any farming to make the land productive.

This land is leased to farmers to pursue profits from the business of farming (or horticulture etc). Low margin cash flow results in relatively low lease rates relative to the capital value of the land.

The latest offering is from the NZ Rural Land Company Ltd.

I have never witnessed one of these opportunities deliver the investment returns hoped for by the investors and I don't think this should be a surprise.

Intuitively you know that farmers work very hard, live on the smell of an oily rag (low cash flow) and then only exit with retirement wealth if they achieve a capital gain when they ultimately sell the land (if not passed down the family).

If land delivers such modest cash-based returns, and 0.00% interest rates are already factored into the current land price, where will the future upside come from?

All of the retail land investment schemes I can think of incur annual management fees for the third parties that present the opportunity to investors. These fees claim another part of the already low cash flows that are available, often compromising the long term returns to the investors leaving capital gain as the only potential for wealth expansion.

Kiwis have been in the property speculation game too long now; we need more of our capital to go into genuinely productive enterprises.

As if reading my mind, an email appeared in my inbox from Allied Farmers (ALF). It confirmed that they had purchased a 50% shareholding in…. the management company for NZ Rural Land Company Ltd.

ALF will receive income from NZ Rural Land Management Ltd, which earns fees from managing the NZ Rural Land Company Ltd!

It's not hard to spot the winner here.

EVER THE OPTIMIST

It's a shallow survey, but I am pleased to hear many more planes flying over my property each day.

Investment Opportunities

Property Syndicate – TWC Quantum is proposing to issue shares in a recently renovated building in Wellington, converted into residential apartments.

A long-term lease will be put in place to give investors a defined income.

The projected income, after expenses, should allow for quarterly dividends at a rate of 7.50% per annum.

It is proposed that the building will be funded by 50% equity and 50% debt with a proposed minimum investment size of $10,000.

Clients are welcome to join our list to hear more once the formal offer is made (expected in mid November).

TRAVEL

Kevin will be in Timaru on 3 and 4 November to meet with clients (and to reminisce) and Christchurch on 27 November.

David Colman will be in New Plymouth on 3 November and in Whanganui on 4 November to meet clients.

Johnny Lee will be in Christchurch on 25 November.

Edward will be in Auckland on 20 November and will see clients in the CBD.

Please let us know now if you would like an appointment in your town.

Thank you.

Mike Warrington


Market News 19 October 2020

Covid19 and potential vaccines have become outsized stories in the media, alongside a constant barrage of political pieces.

I see even Jacinda is promising 'vaccines by Christmas', which feels like a glaring example of over-promising and …

I decided to spend some time reading all that I could find on the status of Covid19 vaccines; digging deeper was a useful exercise.

I am convinced that the quality of the human brain and the speed of current technology for processing data means that the world will have Covid19 treatment options 'soon' (2021).

There’s no point in my guessing their effectiveness other than to say they will help to restrain the impact of this highly contagious health threat.

The more effective the restraint (control) the more freedom will return to normal movement by the population, which in turn is to the broad benefit of economics.

Thus, from an economics perspective Covid19 is a short duration problem. By short duration I mean 2-3 years, whereas by contrast our economies are very long duration.

You and I need the Port of Tauranga (POT), and many other businesses, for decades so a 2-3 year health problem only has a modest impact on present value, which you can see in the current POT share price.

I read that the world has 211 registered Covid19 vaccines under development and nine have already reached phase 3 trials (last stage prior to wide distribution, if safe).

I don't want to get into the political debate of which nation will 'win' the prestige of delivering effective Covid19 vaccines first, but there will clearly be more than one. Politics is the art of doing and saying things that will attract votes/support (economically valueless!) whereas science is the assessment of evidence and pursuit of facts.

My favourite quote though was iced with politics, emanating from China – '3,000 of our employees and their family members have voluntarily taken the trial vaccine'. (bold highlight is mine)

With respect to the world's health everyone should hug a scientist (and a nurse – Ed) and ignore politicians.

I am certain that the world's scientists will improve the health landscape again and I hope that regulators and insurers don't impose unreasonable restrictions on population movement in future.

INVESTMENT OPINION

Australia vs NZ – For the first time in many years Australia and New Zealand's governments seem to be pursuing quite different economic programmes.

This will surely lead to different economic outcomes and investors should factor this evolving situation into their thinking.

I am certain that if I asked Jacinda Ardern and Scott Morrison the same question  about who will be more successful (jobs, economic growth etc) they would both predict victory 'locally'.

The most polarising item relates to tax:

Australia – tax cuts, accelerated spending, 'push' the economy and hope this delivers the tax revenue and net financial position required by the nation;

New Zealand – tax hikes, hoping debt control and a restored financial position will lead to a better financial outcome.

Both live in hope but they are now separating at the 'fork in the road'.

The 'spend now, worry later' Australian option may not feel right to many conservative households, but my instincts tell me that Australia is likely to enter a period (years) of outperforming NZ economically speaking.

From a patriotic perspective I hope I am wrong.

Maybe this situation is a bob each way, because if Australia does well we are presented with a wealthier customer to sell products and services to? (if the skies and borders are opened – Ed).

It's an interesting development and one I'd like our leaders to keep a close eye on, just in case the local strategy shows signs of frost burn.

Placement Issues – EROAD's share purchase placement (SPP) last week continued the evolution of how businesses raise new money (equity) without doing a pro-rata Rights issue to the current owners (shareholders on the register).

The results of the SPP confirm that an investor's prior shareholding influenced the shares received in the SPP. I know three people who sent in the maximum $50,000 and all received a different allocation of new shares, but in each case the allocation reflected a similar ratio to their original shareholding.

A fair outcome you might say.

Well, maybe, but maybe not.

This proportionate response is indeed progress from the early days of SPP where most applicants received the same number of new shares regardless of the scale of their prior investment with the company.

This disruptive allocation process quite rightly fuelled intense criticism of the businesses.

Imagine if you owned 10% of a widget making company and then you were told by the directors that they had doubled the size of the company through a placement of shares to new investors and that you may access a small handful via an SPP, leaving you now as a 6% shareholder of the business?

Imagine if your prior holding happened to be 51% (i.e. control of the company).

I understand the need for a business to attract new capital and to widen its share register, which was a significant driver for EROAD who wanted to invite Australian investors on to the register as the company became dual listed on the ASX.

This was quite clearly the motivation for ERD because they appointed two Australian share broking firms to manage the overall transaction.

This made sense and ERD directors quite rightly view these developments as adding future value to the business for all shareholders.

However, let me come back to why an SPP may yet not be entirely fair to retail shareholders of a company.

A retail shareholder has no idea how much demand there will be for a SPP offer before they must submit their application for more shares (ERD offer was $8 million, they received $18.46 million of requests from 1,236 shareholders).

If an investor is enthusiastic about gaining additional shares they are likely to send in more money than for the shares actually sought; the people I spoke to sent in the maximum of $50,000.

These investors accept that the company may choose to retain the whole $50,000.

However, what really happens is that as soon as demand exceeds supply (see ERD example above) the company begins to scale back allocations based on a person’s prior shareholding.

The investor has essentially provided the company with a free underwrite (certainty of settlement) for its SPP and underwrites (risk transfer) should not come free, especially if the scale of the financial risk is unknown and thus cannot be factored into the purchase price agreement.

I don't want to pretend that a pro rata Rights issue is the only way a company can raise new equity because this clearly makes it very difficult to encourage significant new investors to support a company within a short time frame, however, board directors need to be very careful about any share price discounting offered when placing new shares and immediately diluting the current share register.

For you, the investor, you'll never know the scaling (reduced allocation) impact until after the offer closes. It's just a risk that you must factor in to your decision making.

Scaling – Extending from above, but changing into the market for Initial Public Offers (IPO) of bonds and shares, one of the most common questions investors ask when participating in a new offer is 'will my request for an allocation be scaled?'

A supplementary question is usually, 'if the risk is 50% scaling shall I double my bid?'

Our answers are always:

There is no way of knowing the impact of scaling until after requests are in. This knowledge rests solely with the decision maker at the company raising money and the lead managers, and even then this knowledge comes after the close off for the deal;

No, you should not increase your bid artificially. Accuracy is always the best information to present;

Any bid presented is irrevocable, we cannot withdraw it from the process after bids are in with the company, so if you ask for double and receive it then payment is required. Please be sure you can tolerate this risk if you ask for a large allocation.

Statistically speaking we are rather proud of the allocations typically received by our clients in bond and share offers presented to the market.

Centralised Crypto Currency – development is not off to a good start.

Seven (egotistical) central banks have met to set a framework for how digital currencies might work in conjunction with paper money.

The report highlights three key elements of the proposal -- cryptocurrency coexisting with cash in a flexible payment system, supporting wider policy objectives and promoting innovation and efficiency.

How exciting (not). I can see the whiteboard, mints and water carafes now.

Wait, here's a few more buzz words: the core features of the digital currencies are that they will be resilient and secure to maintain operational integrity, convenient and available at a low or no cost to end-users, underpinned by appropriate standards and a clear legal framework and have an appropriate role for the private sector.

The seven bankers were: Bank of International Settlements, Bank of England, U.S. Federal Reserve, Bank of Canada, Bank of Japan, the European Central Bank, Sveriges Riksbank and the Swiss National Bank.

No Bank of China, a leader in technical developments for crypto currency?

 

No Australia or New Zealand, two other heavily traded currencies in foreign exchange markets. India, Russia, Africa, Latin America?

This elitist approach to internationally linked, countrywide, crypto currencies will have like private providers of crypto currency and alternative methods of instant payments rubbing their hands with glee.

I had hoped that technology (crypto currency) would have enabled real time, trusted, free, payment methods (without cash) for all consumers would have been with us during the 2020’s but it is looking a lot less likely based on the minority trying to dictate how it should work.

 

EVER THE OPTIMIST

Credit card debt in Australia has dropped by 23% over the past six months to $20.6 billion, its lowest level since 2004.

Some will have been replaced via the new laybuy finance schemes but it appears that the penny has dropped for consumers; repay the ludicrously expensive debt and build up some financial reserves to cope with the next financial pressure point.

ETO II

The NZX deserves to feel a little relief after learning that even the mighty Japanese stock exchange was forced to close due to technology issues a couple of weeks ago.

Apparently they don't even stop for natural disasters, so it was clearly a serious matter and would have involved a lot of bowing.

Investment Opportunities

TWC Quantum is proposing to issue shares in a recently renovated building in Wellington, which is currently being converted into residential apartments. A long term lease will be put in place to give investors certainty of income.

The projected income, after expenses, will allow for quarterly dividends, at a rate of 7.50% per annum.

It is proposed that the building will be funded by 50% equity and 50% debt.

It is proposed that there will be a minimum investment size of between $10,000 & $25,000. This will be detailed in the offer document once completed (likely in November).

Argosy – ARG completed its $125 million 7-year bond offer last week, with an interest rate of 2.20%.

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

TRAVEL

Kevin will be in Timaru on 3 and 4 November to meet with clients (and to reminisce).

David Colman will be in New Plymouth on 3 November and in Wanganui on 4 November to meet clients.

Edward will be in Auckland on 20 November and will see clients in the CBD.

Please let us know now if you would like an appointment in your town or if you would like us to visit your area.

 

Thank you.

Mike Warrington


Market News 12 October 2020

If you are worried about inflation, the Chair of the US Federal Reserve says not to be.

He is urging the US government to increase its fiscal support for the economy and declares that 'the risk of over doing it is low'.

In typical Trump fashion, he responded by cancelling the latest proposals to boost government spending!

INVESTMENT OPINION

Self-directed Investors – These are our type of client; people who have elected to manage their own investment decisions and to include some financial advice in the process.

So often this group of investors are criticised through sweeping generalisations for their lack of skills and for errors made with managing risk. The latest such story in NZ was sourced to the Financial Markets Authority who were critical of Kiwisaver investors for changes to the risk settings in their funds 'at the wrong time'.

The FMA also likes to poke the barb at financial advisers for what they consider to be poor form.

Maybe those investors who made significant changes to risk settings didn't receive financial advice?

This thought reached the keyboard after I read a confidence building (for you) article about how well self-directed investors, with financial advice, had performed during 2020 which traversed the extreme volatility initiated by responses to Covid19.

The article used US statistics to describe how the vast majority of self-directed investors had not altered their investment portfolio at all and that most who did actually increased their risk taking (added money to ETF's and a selection of mutual funds) during March and April as share prices fell dramatically.

Now, as market prices have increased these investors are progressively reducing their risk positions.

In behaving this way, the passive investor has ridden out the storm, and the majority of the active investors have extracted net increases in wealth between February and August 2020.

This should bring a smile to all of you, and your financial advisers!

Vanguard (the world's largest fund manager) statistics are consistent with the report, showing that only 5% of their self-directed investors made changes to their portfolios between February and June 2020, of that group less than 0.50% made significant reductions to their risk settings.

Here in NZ, and in our microcosm of data, I'm pleased to say that we witnessed similar behaviour to that being reported in the US with the vast majority of you sitting still with your portfolios and investment rules (asset allocation) and thus you bridged the financial crevice that was the share market in March and April very well.

I've no idea what the next disruptive event will be for investors, but I am increasingly confident that you'll handle it well.

We'll be pleased to be the provider of financial advice and to help you keep an eye on your asset allocation.

Online Meetings – Annual meetings were already migrating toward a hybrid state of physical and online attendance. It enhances participation, which is a good thing.

Covid19 has confirmed how easy online communication can be, especially when it's the only option. Let's evolve based on this new development.

The technological enthusiast will be excited by the prospect over another 'app' or website to connect into such meetings and will one day hope that they can load live questions as a meeting develops.

However, I'm reasonably confident that the last thing most of you want to do is open the 'LUMI app' and join an Annual Meeting of a business that you own.

Computershare has boldly offered up its main phone number for people to call if they have questions or are struggling with the technology. They might regret that.

I have called loudly to you all a few times to make sure your vote is heard, and in my view you should appoint the NZ Shareholders Association as a Standing Proxy to represent you at meetings.

I still recommend this option, strongly, because it adds leverage to the NZSA presence and it means you can head to the golf course or café and not open the LUMI app on your phone in the middle of your preferred social event.

I will personally become a little more interested in the technology when it develops a capability of reaching out to me, live.

I'm imagining that I have downloaded the LUMI app (or similar) and established a constant connection through my CSN so that LUMI delivers a message box to my phone asking if I wish to join the meeting (finger print of FIN to connect).

Once connected it would scroll any relevant news from the meeting, invite live questions (limited character numbers) and throw up voting buttons live for me to respond to (For, Against, Abstain).

I think the majority of shareholders would stick with the NZSA Standing Proxy option, and should for leverage, but the technically enthusiastic would enjoy contributing via an app and attendance at Annual meetings should rise significantly from today's poor attendance levels.

Australia vs New Zealand – There is an interesting conundrum emerging in the South Pacific.

Australia is cutting tax rates and choosing not to pursue further monetary easing (negative interest rates).

New Zealand (Labour Party and Green Party proposals) is promising tax increases and more monetary easing (negative interest rates, direct lending from the central bank).

They can't both be correct.

Near term, to inject more relative cash into the economy should ensure that Australia performs better than NZ on economic activity, employment, and asset valuations.

The Australians appear to be backing themselves to have their economy deliver greater rewards than today's extremely low interest rates. This makes sense to me because if one can't make progress with interest rates below inflation levels then one should handover the reigns to someone else!

This scenario might increase Australia's tax take (it would if they simplified their GST rules – Ed). It will need to, to establish a path toward debt repayment.

Longer term, it is hard to estimate what the larger debt pile will mean for Australia, but at current interest rates it won't cost them much to try and wait this out and if well led it could carry Australia forwards relative to New Zealand.

Missing cash – A fun story that surely makes regulators (monetary and crime) cringe:

In the UK GBP 50 billion of notes are unaccounted for (not recorded in savings accounts or via transaction activity).

GBP 50 billion is roughly equivalent to the new, high, debt target that NZ is working towards post Covid19 spending!

Demand for issuance of paper notes (money) continues to increase, but cash used in legitimate transactions is, logically, decreasing.

Where is the money going?

The statistics imply a rising level of non-disclosure, which further implies a broadening of crime, and untaxed use of that money.

Who'd be a regulator.

Crypto Tax – This is an interesting development given the story about missing money; for all those trading in the crypto currencies like Bitcoin, the NZ IRD has asked crypto companies for their trading data.

Gains made from trading (intention to sell when buying) are taxable, and the commissioner would like an appointment please to collect taxes.

Vector – What if we could convince the community trust gravy train to be wound up and release the capital to the public?

Entrust is the community trust that owns 75.1% of energy distribution and metering business Vector (VCT), doing so on behalf of the Auckland public (340,000 beneficiaries of the trust).

Other regional energy distributors passed out the shares (capital) to the public long ago, concluding that inserting a trust into the ownership sequence added no value to either the business or the public.

The previous Chair of Vector, Michael Stiassny, appeared to not see eye to eye with the trust as the major shareholder and I suspect this had something to do with the less than commercial nature of Entrust as majority owner.

Where I am heading with this thread is to pose a question:

Would Vector and the Auckland economy be simultaneously better off if Entrust distributed its VCT shares to the beneficiaries for them do as they please with those shares? (and wound up the trust)

The value of those VCT shares is currently $3 billion dollars, almost $9,000 per beneficiary.

In a post Covid19 situation, with the obvious financial tensions all around, wouldn't it be better to pass the flexibility of this 'money' to the people rather than retain it in an unnecessary conduit?

Remove a layer from the ownership cake and release funding to far more important objectives.

Entrust Chairman William Cairns used exactly this point when announcing the latest pay out of $95 million to beneficiaries from the VCT dividend (down from $120 million last year).

'This year's payment comes at a critical time, following the economic shock of Covid-19 and for many families, every dollar counts in the household budget particularly as other support initiatives are ending, including mortgage holidays and the wage subsidy.'

A $3 billion capital injection would have been better!

Whilst I don't think councils should own any more than 50.1% of important businesses (waste of ratepayer money thereafter) at least they have some regulatory authority in their area, Entrust does not. Vector is regulated by the Electricity Authority and Commerce Commission.

I don't have the energy (haha – Ed) to start a petition, nor do I live in the Auckland region, but it feels like the right time for us to debate the whereabouts of this country's economic wealth and to better align it with our liabilities and best chances at success.

 

EVER THE OPTIMIST

Rocket Lab continues to feature in my world of optimism, this time proving that good business can transcend politics and succeed in both New Zealand and the United States simultaneously.

Rocket Lab is about to begin launches for NASA from Virginia (Launch Complex 2) and if they meet their monthly scheduling, they alone will make it the second busiest launch spot in the US (Cape Canaveral is the busiest).

LC1 in Mahia, NZ, will remain the company's most active site.

Rocket Lab now employs 600 people, with 450 of them in NZ.

I really do hope that Peter Beck becomes NZ's next billionaire, from productive pursuits rather than from leveraged property investment like most other people’s equity increases in NZ.

Investment Opportunities

Argosy Property – is back, with another proposed bond offer, for a 7-year term.

You'll be quite used to this by now!

A presentation was released today, including a minimum interest rate of 2.20%

No brokerage will be charged to investors in the new issue which will be booked by contract note..

We have a list for investors wishing to participate in the bond offer, this week.

 

Oceania Healthcare – completed the issue of $125 million worth of new 7-year bonds at 2.30% last week.

They’ll be pleased with the success of the issue, and the lower price, having been forced to delay their issue due to Covid19 impositions on the market earlier in 2020.

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

Other new issues – It was a little disappointing to see Vector (VCT) and Port of Tauranga (POT) issue bonds to institutions only recently, making it impossible for retail investors to participate.

I don't walk in the shoes of the VCT and POT decision makers but the only reasons to exclude retail investors when you are already an NZX listed company (making disclosures) is convenience (pricing would be similar).

The interest rates on these two bonds were well below 2% (inflation target), set at 1.575% (VCT) and 1.02% (POT), and negative real returns are beginning to have an impact on the enthusiasm of retail investors, many of whom would rather own the company than lend them money on current terms.

If we are to lend money at today's low interest rates would you rather see a community good from the cheap pricing?

I read about a bond issue completed by Community Finance (https://www.communityfinance.co.nz/) last week, paying an interest rate of just over 2.00% with the money lent to The Salvation Army to support their community housing project(s).

I guessed that many of you would support such bond offers (reasonable return, excellent use of funds), given the opportunity so I spoke to Community Finance about the potential.

They are very keen to migrate from 'wholesale only' funding, to being able to offer Product Disclosure Statements (PDS) and thus include investment from retail investors.

I asked them to give us a call when that happens. It won't be this year, but it is on their radar so maybe 2021 is a chance.

TRAVEL

Kevin will be in Timaru on 3 and 4 November.

Please let us know now if you would like an appointment in your town.

Thank you.

Mike Warrington


Market News 5 October 2020

October already, and the jolly radio stations are trying to inject Christmas carols into the programme.

It has now been six months since our complete lock down for Covid19. Time flies.

‘We’ are up and running far more actively than the doomsaying headlines contemplated; good on us.

Book your summer holiday spots if you’re going.

I had originally contemplated an idyllic Christmas holiday, reminiscent of those when I wore size six shoes but clearly that is not going to be the case.

This is of course excellent news for the domestic economy.

INVESTMENT OPINION

Bonds – I used to think that interest rate markets traded quietly in the corner of financial markets whilst shares, foreign exchange and property markets claimed all the glory.

Interest rate products, such as bonds, were simple things with predictable cash flows, usually well-defined and thus less volatile than other market products and easier to understand.

However, 34 years later I think it is bonds that confuse people the most, including accountants and analysts, but most definitely journalists.

I see no need to record names from last week’s media article that rattled my cage but armed with more than a little knowledge I get tired of such rubbish.

The journalist threw up a misleading headline by describing the recent Auckland Council bond (AKC130) as mispriced and a $45m bonus to investors.

The writer is referring to the change in pricing for the Auckland Council bond over the past 10 days since the new bonds were issued. The bond has recently traded at a market yield of 2.50%, which relative to its 2.95% Coupon rate (interest payments) sets a current price of about $109 per $100 of bonds.

I don’t recall headlines describing increasing fuel prices as a gift to Z Energy shareholders, oil being another benchmark with constantly changing prices and a variety of participants extracting a margin.

Market conditions change, by the minute, compounded by the hour then day, week and month. You get the picture.

A 0.45% yield movement is indeed a large change, but it needs to be broken up into different drivers.

Some of it is explained by declines to underlying interest rate markets (falls of between 0.05%-0.15% depending on your reference point).

Some of it is explained by the price of liquidity. There needs to be a profit opportunity between the prices presented to the market by buyers and sellers.

In the current Covid19 central bank setting banks (who do a lot of the buying and selling of bonds) are demanding wider profit margins from the risks they take with bond trading. Back in the good old days this buy/sell spread might have been 0.05% for wholesale transactions but this is more like 0.10%-0.15% now, if you can find a price.

You all know that retail pricing is wider than wholesale so the spread between buyers and sellers for smaller transactions is more like 0.25% - 0.50%.

The spread should be narrower on very long term bonds given the greater profit potential from each 0.01% movement, however, traders don’t provide free lunches (nobody does – Ed) so they’ll try the wider price every time.

The transactions to buy AKC130 bonds on the NZX secondary market, after the issue closed, have been relatively small, retail, transactions. They have in my view looked like buyers who have not sought financial advice; the investors have agreed to proceed with a transaction based on availability, not price.

The sellers look like professional investors to me; they made sure ‘a price’ was available.

If a small retail transaction moves a yield lower (price higher), an astute professional fund manager will increase the price of their next offer (lower yield). They’ll allow small transactions to move the price reasonably large proportions (if they can get away with it).

Actual turnover in the AKC130 bonds has been tiny relative to the $600 million bonds issued.

So, I can easily explain away a yield decline of 0.30% - 0.40% for the pricing of the AKC130 bonds this week relative to the week of issue, where none of it has anything to do with the Auckland Council Chief Financial Officer’s competence, or influence.

The astute will notice that I have left 0.05%, perhaps 0.10% unexplained.

Maybe this is the additional value that Auckland Council left on the table for investors. This won’t have been intended, but let’s give them some latitude, they have just issued the first 30-year bond in New Zealand. (excluding war bonds that I read about, including bomber bonds (cool name) that were perpetual at 3%).

This is a good segue to my next point; given that Auckland Council manages very long life assets then long term funding (liabilities) is a logical part of their funding programme mix, and, with interest rates so low (+0.95% relative to the inflation target) aren’t they finally applying some improved financial wisdom?

Doesn’t debt for 30 years at a possible real cost of only 0.95% strike you as relatively cheap as a rate payer?

If NZ offered homeowners 30 year mortgages, as they do in the US, and the interest rate was 2.95% what action would you be taking?

Whether or not we believe in 2.00% inflation long term the central banks of the world have made it clear they will fight hard to inject inflation into our economies so I remind you of a market mantra – ‘Don’t fight the Fed’ (aka don’t swim upstream as an investor).

2.00% inflation is a credible basis upon which to make your interest rate decisions at present.

If the primary benefits to the Auckland Council were the volume of money raised and the term of the debt, during a period of low nominal and real interest rates did they really need to spend much time debating 0.05%-0.10% yield/price variance on their bond?

At this point, remember that the council received expert opinion from its lead managers, and I hope the Local Government Funding Agency too, as they attempted to define a fair interest rate that would generate sufficient demand for New Zealand’s first 30 year bond.

2.95% was the distilled conclusion of all these expert minds.

The media headline was not ‘incompetent financial advisors revealed following AKC130 bond issue’ or ‘Financial Markets Authority alleges misleading and deceptive behaviour by financial advisors’.

With the benefit of hindsight, which you never have when making real financial decisions, perhaps the council could have saved, say, 0.10% interest rate. The deal closed early as a result of high demand and the yield has declined post issue.

They might have saved my guesstimated 0.10% by tendering $200 million of the AKC130 bonds using tension to establish a price point and then offered an additional $400 million at that price to all-comers immediately afterwards.

A saving of 0.10% is approximately $12 million in value, which is amortised over 30 years!

If AKC had taken two bites at the deal I suspect that many of the investors would tell me I am being too tricky by half and would not have bought the bonds, and thus Auckland Council would have received less funding, reducing the financial saving the journalist would have described to its rate payers.

Given that this ‘bargain’ was so easily discernible as the ‘deal of the century’ before the issue concluded I applaud this journalist for investing an oversized sum in the bonds for her portfolio and she is no doubt wearing a wealthier smile today.

If you’ll allow me to have more fun, and assume that the journalist purchased $100,000 of the bargain bonds. She can sell these today for about $109,000 (less brokerage! – Ed).

The same $100,000 into electricity generators last week would also now be about $108,000; presumably her next headline will focus on the fools who transferred this wealth from taxpayers to investors.

One last point, the NZ government (Debt Management Office) hasn’t yet been brave enough to offer a 30 year bond, even though they have an urgent need for a lot more long term funding and they know the Reserve Bank will buy their bonds.

I think Auckland Council should be applauded for their leadership and if the marginal cost was 0.05% - 0.10%, so be it.

Something tells me the council will be rewarded for this action and I hope the journalist I speak of is young enough to update her review of the situation every 5 or 10 years.

Register of Trusts (and other entities) – This frustrating story of 134 family trusts claiming the Covid19 wage subsidies should reinforce two points to Cabinet:

The need to have MBIE actually begin auditing the appropriateness of each recipients claim; and

The need for all entities (trusts, partnerships, societies etc) to be obliged to join a register in the same way that companies must and thus be drawn closer to the regulatory ‘eye’.

It was a failure of the previous government when they rejected proposals to have all entities in New Zealand join a register, especially trusts which just had their Act of parliament renewed!

Everyone, except the mischievous, would benefit from trusts being registered with the registry being overseen by the Ministry of Business Innovation and Employment (MBIE), as it is for companies.

A unique registration number would be issued, trust deeds and amendments would be stored (discretely) for legal reference, active trustees would be recorded and AML verified (!!), annual declarations would be made (meeting legal obligations), key accounting information could be stored (discretely but accessible by IRD) and there would be a process for sharing a copy of the discrete information by its ‘owner’.

If one nominates access to the registered entity for a solicitor and accountant this would add value to the status of the trust.

I’ve proposed previously that such a register, measuring AML compliance, would centralise the AML process and thus make it hugely more efficient than it is currently.

IRD should find alignment between tax returns and annual regulatory filings.

One’s thing’s for sure, a lot less trusts would have applied for wage subsidies.

Surely amongst all the point scoring political nonsense and financial bribery (note to SFO about buying votes – Ed) we can develop some good quality long term governance?

Tiwai Point – I know I promised not to comment about politics, so I’ll phrase this differently (suit yourself! – Ed).

The political pledge to ensure that Rio Tinto exits the Tiwai Point Aluminium Smelter over a longer time frame (additional years) to help employment and economics in the region is more about smoke than fire.

Yes, it delays the change to employment in the region, however, the majority of the taxpayer subsidy thrown at the situation will reach Rio Tinto, the NZ electricity generators and Southport.

Check out the share price movements on the date of the political announcement (Monday 28 September) for the electricity generators – CEN, MCY, MEL, TPW, SPN.

It would appear, again, that governments and central bankers are choosing not to learn about this pass through of money from the many to the few so it will continue to happen.

I think this falls comfortably into the law of unintended consequences and discloses a problematic lack of financial and negotiating acumen by our politicians.

Make your investment decisions accordingly.

Green Ratings – As I feared, simply issuing ‘Green Bonds’ and making changes to satisfy ‘Green’ auditors is not reducing the carbon intensity of those businesses, according to a research report from the Bank for International Settlement.

These businesses are making an effort to improve; it’s just that the results are modest or short term in benefit.

Nobody’s giving up on the cause though. Governments and central bankers are determined that the financial markets will provide them with the leverage to force a change in behaviour.

I think they are right.

Now, the BIS ponders the merit of a ‘Green Rating’ for each business.

They propose a rating scale that slides from five G’s to five P’s (GGGGG, GGGGP…. GPPPP, PPPPP). G is for Green, P is for Pollution. You get the picture.

If the rating is developed and then becomes part of central bank regulation then it will influence bank policy and thus the pricing of, and access to, money required to run a business.

Imagine being able to link company tax ratios to such a green rating?

Increasing the cost of capital for a business and reducing its net income would unquestionably influence decisions made by the company directors.

Displaying greenness always gained some moral support, but morality alone will not drive wide change across business; financial pressure will.

If the BIS and environmental scientists can establish a widely accepted measure for carbon intensity, and thus increase/decrease, then the proposed rating system will gain credibility and thus effectiveness.

This concept stands a better chance of driving more change globally than New Zealand yelling about our moral stance on cancelling mining licenses or worrying about farting cows in the South Pacific.

Finally, environmental behaviour is becoming more important as a performance indicator for businesses.

 

EVER THE OPTIMIST

I have had fun playing a new game. It only takes seconds each day.

Tally the ‘glass half full’ versus ‘glass half empty’ headlines.

Most days ‘half full’ wins, thank goodness.

ETO II – one useful side effect of the Covid19 situation is the increasing incidence of trade surpluses.

The seasonally adjusted trade balance for the June 2020 quarter delivered an impressive $1.4 billion (+$426 million for June) according to Statistics NZ release and this included the importing of our new naval ship HMNZS Aotearoa.

If by some chance we start to record ongoing trade surpluses we are a chance to actually be able to service (and reduce) our debts as a nation!

Investment Opportunities

Oceania Healthcare – new 7-year bond offer opens this week (maturing 19 October 2027) with a minimum interest rate set at 2.30%p.a..

Interest will be paid quarterly.

The deal opens today and closes on Friday; it is a fast-moving contract note offer with OCA paying the brokerage costs (clients do not pay costs). There is no application form.

If you wish to invest in this bond offer, please act now and join our list (email or phone) prior to 5pm on Thursday 8 October.

My Food Bag – I see this company is pondering whether an Initial Public Offering (IPO) is the way for current owners to partially exit the business.

They plan to make a decision (trade sale or IPO) by the end of 2020, so an IPO in mid 2021 is at least a possibility.

It would be nice to see more of our local businesses ‘grow up’ further and become available to the public for investment.

TRAVEL

Kevin will be in Christchurch on Wednesday 21 October.

Please let us know now if you would like an appointment in your town.

 

Thank you.

Mike Warrington


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