Taking Stock 25 August 2022

 

Chris Lee writes:

PERHAPS there are a few hundred thousand New Zealanders who might genuinely be labelled as ''investors''.

In reaching this figure I do not include those people, some several hundred thousand, who are seeking the knowledge to become an investor by engaging with no-cost, no-minimum, trading platforms like Sharesies. (I hope many of them do graduate, as they acquire savings that should be invested intelligently.)

Of the few hundred thousand real investors who buy and sell shares or bonds, or who buy properties to rent, or who make conscious decisions over their KiwiSaver or other managed fund choices, nearly all, certainly 90% of them, are greatly protected by the law, and they need that protection.

They would be in genuine peril if we did not have many layers of protection for the vast majority of investors.

Such protection includes regulations, supervision of providers, sensible constraints on advisers and on salesmen, logical company laws, great dependence on competent governance, all backed by sanctions that rightly seek to ban self-focused promoters, cheats, thieves, or the clueless.

We have some effective support for investors, and almost all of them depend on that support.

But we have some unsolved problems, resulting from law that was made without the quality of consultation that should have included streetwise, competent financial market leaders.

One of those problems was in the limelight recently.

A major support for investors should be supplied by high-quality governance, performed by skilled, experienced people with the rare qualities of real, relevant knowledge, mixed with a true appreciation of social, financial, and legal obligations.

The issue was raised during a paid function in Auckland when a law firm that I respect invited market leaders and insolvency practitioners to hear the law firm (call it ABC) to hear ABC's views on directors' duties and what investors are entitled to expect.

The law firm, in a lengthy lunch-time presentation, argued, in effect, that directors had little to fear if they were decent honest people and did the best they could to govern wisely. ABC believed that directors were not required to be analysts.

A section of the audience was outraged.

Utter piffle, they countered.

If that were ABC's views, the naysayers announced, then ABC should have no clients. An experienced director stated this in response to a request for audience feedback.

This summarises my response to ABC's contention:

Piffle; balderdash; an opinion offered to shield incompetence.

Further invitations to react were stopped by the MC.

Time to go home, before fists flew!

The ABC viewpoint could not be further from the view of the courts.

Directors owe to retail investors the commitment not to be nice, apple-pie, aimed at harmonious, mutual mediocrity.

Directors owe expertise, analysis, helpfulness, strategic wisdom, inquisitiveness, argumentativeness, and they simply must stress test all the planks that combine to build the company's platform.

If a majority shareholder says he would underwrite a cash issue that might be needed, let him prove it to the satisfaction of directors.

The ABC view was so far from what retail investors are entitled to expect that one wonders how urgent is the view of the Supreme Court, to offer details on governance expectation.

The country is still waiting for the Supreme Court to adjudicate on an appeal, and a counter-appeal, by the failed Mainzeal directors, who allowed the company to trade while insolvent for many years, believing that all would ''come right'' and that if it did not come right, the Chinese majority shareholder would backstop the problem.

As far as I know, they did not have the third fallback position of a lien over all coins collected by the tooth fairy.

The Supreme Court decision, not ABC law firm's opinion, may well provide a crucial milestone for hapless directors and victimised investors. Investors must be protected by directors.

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THE Supreme Court Mainzeal decision is not the only upcoming case which investors will watch closely.

I can think of at least two more highly relevant issues to be resolved, one involving the level of privilege that our big banks can assume, the other involving a plea to regulators to find a more practical boundary for those who make offers to wholesale or eligible investors.

The relevant case confronting our biggest bank, ANZ, has some curious aspects.

About a decade ago, when Key's government was focused on consumer rights, a law was passed requiring banks to disclose accurately when the bank lent money.

If the disclosure was inadequate, no interest could be charged until disclosure was complete. No interest. Zip!

The banks lobbied Key and his mates. No leniency was granted. The law was passed.

The ANZ soon after realised it had failed the disclosure test, so it quietly offered a large number of clients a modest sum, with little explanation. The surprised clients accepted this unexpected refund, approximately the equivalent of a movie voucher, with free lollipops.

The banks then lobbied that the new law should apply not relitigate past settlements. Again, Key's government declined. The big Aussie ANZ bank was in effect told the law would prevail - no interest at all could be charged till disclosure was correct.

Fast forward to today.

Key resigned from government when the pre-election polls made it clear that he could not hold his post without Winston Peter's support. He had far too much appetite for the top table to accept being leader of the opposition, and a chair at the canteen.

Reflecting the political cunning of the Ocker banks, ANZ engaged Key as first its NZ branch chairman, then as a director of the Australian big brother. Around the time of that appointment that I described as unwise, ANZ had discovered it had not compensated fully for the disclosure errors. As the law stood, it would have to refund all interest collected during the period when disclosure was inadequate.

A New Zealand litigation funder agreed to test this consumer protection law by applying for a court decision to enforce the law.

ANZ, chaired by Key, faces potential refunds of a billion plus if the law that Key's cabinet had designed were applied as written. It would be rare for any law to involve concessions, unless they were contemplated by the lawmakers.

The ANZ case, all about consumer protection, is enticing.

It might be described as being Key versus Key (previous government versus current role of Key).

Do not be surprised if before the platoon of commercial lawyers reaches the steps of the High Court, a confidential, no acceptance of guilt, settlement is reached, with a transfer of hundreds of millions of dollars.

The ANZ would not want the law clarified, enforced, and set in concrete, I assume.

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ANOTHER investor protection case now being initiated is to test the effectiveness of allowing retail investors to self-describe themselves as wholesale or eligible investors, and then invest in offers not suitable for anyone but the most experienced and risk-tolerant investors.

The point of this self-description (of wholesale, eligible) is that it allows investors to take up offers where there is virtually no useful disclosure, and very little to stop extravagant behaviour from those who make the offers to investors. Often these offers end in grief, expectations not matched by performance.

Concerned advisers are now engaging with the regulators.

There are at least three important matters needing much more careful definition by the regulators, with the courts' assistance, if needed:

1. What wealth credentials, and investor ability to analyse and accept risk, would meet the intended definition of this rare category of a ''sophisticated'' wholesale or eligible investor?

2. What disclosures of the promoters should be made, even in a wholesale offer, to ensure all relevant history is displayed for investor inspection?

3. What are the criteria applied when assessing who is a fit and proper person to be soliciting money from the public, and what skills should be evident if the offeror intends to lend or manage other people's money?

Currently any authorised financial adviser, accountant, solicitor, and quite conceivably any beauty contest judge, can validate a self-certified description of a wholesale or eligible investor.

I estimate that thousands of investors have foregone protection, buying the bait of extravagant forecasts, in recent years.

There is guidance but no defined parameters. Some who offer to certify want to see five million of existing investor wealth, some use level of income ($250,000?), some use personal history of investing without detailed, regulated, offer documents.

The guidance needs tightening. It is almost certain that a friendly accountant or financial advisor would sign off a request from an investor, without challenge.

In my view, the definition is worthless, as it is now.

The second issue is disclosure.

Currently a convicted criminal does not need to disclose that conviction. Why not? I would prefer that not only is the disclosure obligatory, but the potential investor should be directed to take advice on what that conviction means. People buying a licence to occupy a retirement villa MUST receive independent legal advice. Surely a wholesale offer could compel investors to visit a competent independent adviser? Surely the adviser should be accountable for any lazy certification processes.

In many areas, disclosure of involvement in company failure (as a director) must be disclosed.

The former National Party cabinet minister, Barry Brill, fought that obligation in court. And lost.

If he had been a director of 100 successful companies, and one dud, he had to disclose the dud.

The court said so. No exceptions.

The third issue will be the focus of intense scrutiny as the regulators (the Financial Markets Authority and the Reserve Bank) are targeted to provide for clearer guidance.

That campaign is underway and has the objective of redefining what constitutes a ''fit and proper'' person.

Currently, the Reserve Bank is sensitive about naming people as ''unfit and improper'', aware that the appeal available could lead to a soft ''second chance'' for people. (''He is reformed, his parents did not love him, he did not mean to steal, etc.'')

The criteria now are highly subjective.

Many entrepreneurs connected with failed contributory mortgage companies, and failed finance companies, are simply too sensitive and too intelligent to test the water. Their underlying IQ and EQ warn them not to try their luck, again, with public subscription. Full disclosure would destroy their credibility with even the greenest of investors.

My opinion remains that people wanting to solicit money from any investor, wholesale or retail, (or so-called wholesale), or to have control of other people's money, should have displayed no history of dishonesty, none in self-focus (at the expense of investors), no failures in governance, and no exploitation of investors.

I shall update investors at the appropriate time, as this matter progresses.

In the troubled years ahead investors will need all the protection to which they are entitled.

Standards of governance, clarity on disclosure obligations, and certainty about how to define a fit and proper person are all issues that need to be resolved.

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THE hundreds of NZ investors who backed the enthusiasm of directors and geologists of the gold explorer in Central Otago, Santana Minerals, were probably in disbelief this week when more SMI assaying results were delivered to the Australian Stock Exchange on Monday.

In an area of the Bendigo/Ophir site that AMI has labelled a ''jewellery box'', there were wonderful results, 40 metres of rock producing an average of around 12 grams of gold per tonne.

Macraes Mining operates well with an average grade of around one gram per tonne.

The source of disbelief will have been the double-checked assay results of two particular metres within the ''jewellery box''.

An assay result of 40 grams per tonne is universally regarded as a ''bonanza'' grade.

One of the two recent assays measured one of those metres yielding 127 grams per tonne.

The other yielded 1400 grams per tonne. That is not a typing mistake.

A cubic metre of rock weighs 2.7 tonnes.

There are around 29 grams in an ounce (not 32 as one textbook displayed).

An ounce of gold is currently saleable at around NZ$2800.

Except for the (sad) group now leaving school who have not learned arithmetic this news will be greeted with joy.

Of course, the drilling continues.

Nobody knows what the next holes will contain.

This is part of the thrill of being an investor in successful gold exploration.

But there remains great optimism that the gold project at Bendigo is going to add significantly to our nation's wealth. Heaven knows New Zealand needs such additional wealth.

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Travel

Edward will be in Auckland on 31 August (Ellerslie) and 1 September (City).

In September, he will be in Blenheim on Thursday 8 and Nelson on Friday 9 and in Napier on both Thursday 22 (Mission Estate) and Friday 23 (Crown Hotel)

Chris has two available times in Queenstown on September 9.

David Colman is planning trips to Whanganui and Palmerston North.

Please let us know if you would like an appointment.

Chris Lee & Partners Ltd


Taking Stock 18 August, 2022

Johnny Lee writes:

REPORTING season has begun, with a smattering of early market updates arriving, that sit broadly in line with what most investors would have been anticipating.

My Food Bag provided a brief update to market, lowering expectations for its full-year result in November.

Nothing in the update would have surprised those ''reading the tea leaves'' and watching the changing economic conditions around the country.

While customer numbers remain broadly stable, deliveries are down, earnings are down, and logistical problems are beginning to appear.

Customers are moving to lower cost (and lower margin) products, including its well-known ''Bargain Box'' product. The prevalence of Covid continues to plague the company, as it struggles to complete timely deliveries, a trend virtually every business is experiencing.

The share price continued its descent following the update, hitting fresh lows as bargain hunters, perhaps inspired by the 13% gross dividend yield, continue to pick up small volumes. Dividend yields, of course, are backwards looking and subject to change, especially when earnings are falling almost 10%.

Contact Energy was amongst the earliest providing their results to market, giving shareholders and other interested parties a glimpse into the future of the electricity sector.

The result itself saw a modest decline in profit year on year, following last year's very strong result. The dividend of 21 cents per share was maintained, with a small improvement in imputation.

While governments around the globe discuss and debate, the likes of Contact Energy continue to actually put in place initiatives to decarbonise and plan our electricity generation future.

The first step remains to accelerate demand for electricity, de-risking new generation and diversifying away from the likes of the aluminium smelter. Developing high electricity usage sectors, like data centres and hydrogen production, remain a priority for Contact, as it looks to sign deals with major users and create mutually beneficial outcomes. This morning's announcement from the Electricity Authority threatens to jeopardise this plan, although details remain too scarce to make a definitive judgment.

The much discussed ''lower North Island battery project'' appears to be on ice, as other opportunities prove to be more cost-efficient. A decision on this is now expected next year.

The next major announcement from Contact will be in relation to the review of its thermal assets, with an announcement coming later this year. The current structure of our electricity market makes balancing decarbonisation, security of supply, and affordability a challenge for the owners of these assets, and Contact remains confident that its earlier proposal is the best solution going forward.

The announcement of the financial results saw the share price modestly increase. Its share price has been remarkably stable over the past 12 months, trending largely in the reverse direction of interest rates, as investors seek yield and weigh up alternatives around the market.

The board continues to plot the long-term future of both the company and the sector at large, amid a period of change for both supply and demand of energy.

Fletcher Building was another posting its full year results, an announcement which saw a climb in its share price in response.

Earnings are up, dividends are up and the forecast outlook remains strong. Those shareholders who maintained their faith in CEO Ross Taylor are now seeing the fruits of his long-term vision, despite the speedbumps along the way.

2020 marked something of a low point for the company, as the worst impacts of Covid were being felt across all its divisions. A large loss, a cancelled dividend and a plummeting share price were causing alarm. Fortunately, this year ended up being something of an anomaly, as 2021 saw a return to profit, and this year's result saw that profitability continue.

There was also positive movement on some of the ''non-financial'' metrics, such as staff safety, carbon emissions and diversity.

Fletcher Building shareholders should be satisfied with the result.

Turner's Automotive Group, the listed car reseller, topped off a fantastic two-year run with its 2022 result, which saw a sharp incline in profit and shareholder distributions.

With the car dealership sector in decline, the larger, better capitalised participants are continuing to gain market share, expanding their geographic reach, as the likes of Turner's take a ''supermarket approach'' to the sector.

Turner's has been aggressive in its willingness to buy local stock, sourcing fewer vehicles from overseas, to ensure that capital employed is recycled quickly. The company is also selling more vehicles using conventional retail channels as opposed to auctions.

The company's finance and insurance arms are both contributing to profit growth, although the finance arm is expecting some challenges as interest rates rise. The increase in people working from home, as well as decreased car usage due to the cost of petrol, has seen fewer insurance claims.

While revenue growth has been more modest, the company is investing in growth, expanding its footprint and its product range, which now includes vehicle subscriptions. It is also attempting to take advantage of the growing demand for electric vehicles, although it notes that this growth will be constrained by the growth seen from our primary source of used vehicles – Japan.

Moving forward, the company remains ambitious about this growth, targeting another leap in profitability after a brief period of moderation as expansion concludes. It notes that the shift from consumers – with demand increasingly concentrating on the lower priced vehicles – will present challenges and opportunities.

Reporting season continues in earnest next week.

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THE Reserve Bank has lifted the Official Cash Rate by another 0.50%, taking it from 2.50% to 3%. Banks have already begun lifting lending and saving rates on the back of the announcement.

The rise was largely predicted. The Reserve Bank also indicated that further rises would occur this year, perhaps taking the OCR as high at 3.75%, before peaking at or around 4.00% next year.

Recent declines in the fuel price would have given the Reserve Bank some cheer, although strong wage growth data is expected to fuel inflation for a while longer.

The big unknown remains the impact of international tourism. An influx of travellers would provide welcome relief to our tourism and hospitality sectors, as well as a boost to our Government coffers. While New Zealand has opened its borders, many countries are now actively competing for tourism dollars, with 2025 being put forward as the most likely date for a full return of travellers to New Zealand.

For now, the Reserve Bank has put forward its plan for tackling inflation and has stuck to it. Borrowers and lenders alike will appreciate a period of predictability.

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Chris Lee writes:

THE skulduggery lurking behind global gold markets is beginning to surface, coming to a head shortly, when a previous Overlord of gold trading is to be sentenced for manipulating world markets.

King of gold trading is the huge American investment bank JP Morgan, whose tentacles are almost as feared as those of Goldman Sachs. JP Morgan is the gold king and has been for decades.

Readers of this newsletter with long memories may recall the comments here after the 2008 Global Financial Crisis, which so devastated countries like Greece and Italy that Europe went on bended knee to China, seeking grants and support for European bond markets. China helped Europe, but it wanted a large favour.

At a high, but suppressed, level the word was that China preferred to be rewarded by a new, stable gold price. It wanted America (read JP Morgan) to maintain a stable, but not rising, price for gold, so China could fill its vaults with gold without disturbing the market price.

JP Morgan, it was said, could control derivative markets to ensure that the price of gold did not inhibit China from buying and acquiring more gold.

At the time, China and Russia had lower levels of gold and a much lower percentage of national reserves than many other countries.

Mysteriously, at a time when one might have expected a flight to the internationally-described ''safe haven'' of gold, the price of the metal fell.

In 2014, gold was around US$1,900 an ounce. By 2016 it was nearer US$1200 an ounce.

Perhaps we now know why.

The head of the JP Morgan desk, to whom every gold investor bowed, has pleaded guilty to ''spoofing'' and is soon to be sentenced. Spoofing is a game aimed at misleading other investors.

In gold parlance, the biggest gorilla places inauthentic buy and sell orders aimed at duping the market, to ensure the prices suit the spoofer. Huge orders would be placed on the screen, within seconds removed, implying transactions had occurred, or sending signals that would bully other market participants into re-pricing their orders.

The gold price was at the very least controlled. Some would say it was suppressed. China's demands were satisfied.

I know there is a link between China's quest for more gold reserves and less reliance on fiat currencies.

Around a dozen years ago, Malta's electricity grid was fuelled by very cheap Libyan oil, a consequence of a contract signed by Malta with Libya's Gaddafi. Malta promised not to drill for oil in the elephant field that crossed into both Libyan and Maltese undersea zones.

In return, Libya offered Malta a 40-year oil supply contract in the early 1970s, at a pricing formula that greatly advantaged Malta.

About a dozen years ago, the contract ended.

Up came a Chinese proposal.

China would rebuild the grid so it could use Russian gas. Later Malta fortuitously switched to Azerbaijan, avoiding drama over the current Russian sanctions.

China's offer to rebuild the grid was at a cost of around Euro 1.6 billion, but China did not want cash. It wanted to be paid in gold. Malta obliged.

That China wanted JP Morgan to ensure the gold price did not rise inexorably seems entirely credible, with the benefit of hindsight.

Today, China and Russia have much higher levels of gold than they did a decade ago.

JP Morgan's king of the gold desk is about to hear his fate for a commodity price manipulation that the USA regards so seriously that the prison sentence could extend to 15 years.

The sentencing is expected next month, according to Bloomberg.

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LAST week I made a light-hearted reference to the old maxim that looking for hairs on the back of one's hand was a sign of madness.

A reader with a sharper memory than mine noted that the saying should have been looking for hairs on the PALM of one's hand.

Thank you. That may mean that not only am I infected with madness, but with a fading memory.

Hopefully my grandchildren will forgive me.

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Travel

Johnny Lee has no appointments left in Christchurch on Wednesday 24 August (Russley Golf Club) .

Edward will be in Auckland on 31 August (Ellerslie), 1 September (North Shore) and 2 September (City).

In September, he will be in Blenheim on Thursday 8 and Nelson on Friday 9 and in Napier on Thursday 22.

Chris has two available vacancies in Ashburton on September 7 (morning).

David Colman will be in Lower Hutt on Friday 26 August and is planning trips to Whanganui and Palmerston North.

Please let us know if you would like an appointment.

Chris Lee & Partners Ltd


Taking Stock 11 August 2022

Chris Lee writes:

MANY of the financial sayings trotted out by financial salesmen or unaccountable media people are simply codswallop.

The advice to ''hold tight, all will come right soon'' is right up there with the publican's advice that six bloody Marys the next morning will cure a hangover.

But one saying is nearly always undeniable.

Do not bet against the bond market (or the Fed).

The sheer volume of money heading one way will nearly always present an impenetrable barrier for those wanting to take the opposite route.

Right now the bond market globally is telling all investors that after another year or two of rising interest rates, the outcome will be such a painful extended recession that those in power – the politicians of the day – will coerce supposedly independent central banks into another era of falsely-priced cheap money. In effect, politicians will fear a deep recession more than they fear inflation.

In financial market parlance, the bond market signal is an inverted yield curve, effectively placing high probability that interest rates will begin falling within three years.

The interbank benchmark now used as the base rate for many transactions are the swap rates.

Long-term swap rates are falling. Long-term bond rates have fallen.

Betting against the bond market is as close to a sign of madness as the daily search for hairs on the back of one's hand, the saying went, in previous days.

Madness may come with age, for some of us.

I may be in that group. I believe the bond market signals will be reversed.

I do not believe that long-term rates have peaked, and do not believe that within three years there will be a reversion to the crazy ''cheap money'' era whose insanity was displayed by ''negative interest rates''.

The evidence to support my view is more visible than the fine silk worn by those emperors who, like Lady Godiva, ride through town, the new attention-seekers urging investors to buy long-dated bonds at 3%.

Here is some evidence:

1. The Bank of England forecasts double-figure inflation in Britain leading to a long-term recession, lasting for years. It forecasts inflation will rise to 13% in Britain, next year.

2. The BOE is to sell back to the market 100 billion pounds worth of government bonds it bought as part of its quantitative easing programme, starting soon, at 10 billion per month.

(Assumption: the market will push up rates, meaning central banks will make huge losses on these transactions, having bought at premium prices, but soon selling at discount prices.)

3. The Federal Reserve of New York expects rising inflation and also wishes to sell bonds back to the market. It expects its current recession to extend.

4. China has found its ''free money'' led to absurd outcomes, especially in its property markets. It can and does create as much money as it likes, without accountability. Free money distorts, the outcome much worse, the longer the tactic is followed.

5. Japan cannot price its money much cheaper. It is still at distortionary low levels.

6. NZ has to reduce its RB holding of securities bought under Robertson's QE programme. Markets are unlikely to over-price their offers.

7. Australia forecasts higher interest rates responding to rising inflation.

8. Labour shortages are problematical in the UK, USA, Australia, and especially NZ, which is now at the tail end of OECD country attractiveness, after a series of errors, including with its immigration settings.

9. Wage demands are the most volatile fuel for inflation. The NZ Government's massive increase in public sector numbers has generated fuel for labour shortages, wage increases, and inflation.

10. The Reserve Bank of New Zealand is not solely focused on inflation, monetary conditions, and the strength of our banking system. It must also consider unemployment, the Maori perspective, and prepare for climate change costs. This is akin to asking the police to take into account hurt feelings before arresting any offender.

11. Inequality – the outcome of free money – now affects such a high percentage of society that the response will be deafening. Look out. Expect rising fiscal deficits, which are inflationary.

Accordingly, I deduce that the fall in swap rates is temporary, and that mortgage rates, term deposit rates, and long-term bond rates must rise, and cannot be jawboned down by politicians seeking an excessively-rewarded seat in Parliament.

Household debt servicing is bound to be a huge social issue. Next year $160 billion of home mortgages will have rates re-set at approximately double the existing rate.

I am betting against the bond market. Perhaps I am searching for hairs on the back of my hand; as some would say, displaying the signs of madness.

If I were a corporate with a debt programme, I would be seeking long-term money now, and would be generous with the rate I offered to potential investors. I would not want to be reliant on bank finance, and I would not be betting that long-term rates will fall.

Expect several such issues of bonds in coming months, hopefully at rates that are not overtaken by time, as we saw during the time when Robertson, the banks, and the Reserve Bank were telling us to prepare for negative interest rates, as though none of them understood the link between free money and destructive inflation.

One can forgive a layman like Robertson – but no forgiveness for our banking heads!

Heaven help us if, for the umpteenth time, we put the re-election of salary-chasing politicians ahead of the need to squash inflation.

Inflation is a scary foe.

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INFLATION is reasonably easy to plot, in the short term.

It is calculated by measuring a somewhat dubious basket of goods and services each quarter.

Annual inflation is the sum of the last four quarters.

To calculate the next quarter, the earliest of the previous few quarters is dropped off and the new quarter is added. If that earliest figure is 1%, and the next quarter will likely be 3%, even a beginner in maths can predict that the next annual inflation is likely to be 2% higher than the previous annual figure.

Historically the Reserve Bank used to measure two baskets, one being the basket applicable to retired people.

That sensible practice was deemed to be unnecessary so today the basket measures the spending of ''average consumers'', perhaps the ''average'' age being mid to late thirties.

That spending measures goods nothing like those that retired households would purchase.

So pensions are adjusted based on a phony figure.

A basket that measures food, fuel, insurance, council rates, and power bills would reflect the increases most retired people endure.

Would such an exercise really be too hard, or too expensive?

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Johnny Lee writes:

THE height of Covid's impact on New Zealand – March 2020 – saw a number of companies in dire straits. Fear was rampant, leading lenders and shareholders to re-price risk. Companies like Kathmandu, Sky TV and Sky City responded by issuing additional shares to investors, shoring up balance sheets to endure what was obviously going to be a difficult period of time.

The NZX responded by engaging with issuers and market participants to ensure they had the flexibility needed to access this capital. Some rules were found to be too restrictive, leading the NZX to implement temporary waivers to these rules.

Now, the NZX is engaging with market participants proposing permanent changes to the NZX rules. Regulatory change and public consultation do not tend to grab headlines, but some of the changes being proposed are highly relevant to long-term share investors.

The NZX rules dictate what listed companies can and cannot do. The particular changes being discussed surround the rules for raising capital through rights issues and share purchase plans.

By and large, the proposed changes simply put into writing conventions that are already in place and will have minimal actual impact. While there have been some historical incidents of retail shareholders being treated unfairly in the past – Ebos received criticism a few years ago – New Zealand's listed companies are generally cognisant that treating all parties fairly works in everyone's favour.

Fair, of course, is subject to one's interpretation.

Retail investors have, and will continue, to require more time than institutional investors to respond to offers and arrange their financial affairs. This often means that institutional investors receive their shares first, allowing them the advantage of trading their shares before retail investors receive their own.

The NZX's recent capital raising was one such offer. Conducted in two parts – an institutional offer and a retail offer - the institutional offer opened and closed on 17 February, with roughly ten million new shares issued at $1.62 per share. The shares were issued on 25 February, when the share price was nearer $1.45.

The retail offer opened on 22February and closed on 11March, with shares being allotted on 18 March at $1.45. Acceptance was very low, as by then the price had tumbled further south. Normally, those who chose not to participate would have been paid the difference between the market price and the $1.45. As there was no excess, retail investors were simply voluntarily diluted.

This style of capital raising – where one group is offered prior to another – is called ''Accelerated'' in investment parlance.

In this instance, retail investors were not unduly punished, as the war in the Ukraine had led to sharemarket repricing that removed the benefit of early settlement. Retail investors could instead buy shares at a cheaper price on market than through the offer.

However, much of this process is governed by convention. There are few specific rules to protect retail investors, who instead rely on their voting power to ensure fairness. Creating rules – for example, a rule that states that the second offer be priced at or below the first offer – makes sense in this context and is unlikely to attract controversy.

Another issue, perhaps more complicated, is a proposal to permanently allow the use of ANREO's.

An ANREO – or an Accelerated Non-Renounceable Entitlement Offer – is similar in structure to the NZX offer above with the key difference that retail investors have no ability to sell or transfer their entitlement. If a shareholder happens to be on holiday, or financiallyu committed elsewhere, they become diluted and receive no compensation.

The Kathmandu offer of 2020 was conducted as an ANREO. This offer concluded with retail investors being diluted and underwriters buying discounted shares with no compensation made to those retail investors.

At the moment, ANREOs are permitted only via a special waiver from the NZX. The NZX is seeking feedback as to whether to allow ANREOs long-term.

Overseas experience suggests that ANREOs would quickly become the preferred method of raising capital.

If this is to proceed, it absolutely must include some retail shareholder protections. There will always be some investors – retail or otherwise – who do not participate in these sorts of issues due to circumstance outside their control. Lost mail, overzealous spam filters or illness are three common causes I have heard in my career. One protection being proposed is to limit the amount of capital that can be raised in this way each year, ensuring that any dilution suffered will be capped at a predetermined ratio.

The other major change surrounds disclosure around underwriting and sub-underwriting agreements.

When companies raise capital, it is commonplace to have agreements with private parties – underwriters - to buy any new shares that existing shareholders do not buy. This ensures that the company raising money will indeed raise the money it requires.

These underwriters, in turn, sign agreements with sub-underwriters to mitigate their risk. Both groups are paid a modest fee for assuming this risk.

When issues are successful, the actual obligation to underwriters and sub-underwriters is minimal and normally limited to those retail investors who do not participate. When oversubscriptions are available, the obligation is sometimes nil. The fee is still paid.

When issues are not successful, underwriters end up writing a cheque for shares they do not want. This then becomes a process of gradually selling shares on market, seeking to minimise losses.

These arrangements are not disclosed to the public in any great detail. Disclosure, particularly with issues where the obligation is substantial, could lead to a scenario where a large, motivated seller is publicly identified, when perhaps discretion would be preferred. I also imagine that such disclosure would be off-putting to some, perhaps impacting the cost and availability of underwriting.

The proposed changes are technical in nature but are an important step for ensuring our market has the correct ''settings'' going forward. The core principles – protecting all shareholders, while providing companies with the tools they need – are the right ones. Ultimately, it may require a balancing act between the two.

The NZX has invited those interested to submit their views before 2September.

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Travel

Edward will be in Wellington on Thursday 25 August (Featherston Street); and in Auckland on 31 August (Ellerslie), 1 September (North Shore) and 2 September (City).

In September, he will be in Blenheim on Thursday 8 and Nelson on Friday 9 and in Napier on Thursday 22.

Chris will be in Takapuna on August 16 (p.m.) and has several vacant times in Ellerslie on the morning of August 17. He has two available vacancies in Ashburton on September 7 (a.m.) and one in Queenstown (p.m.) on September 9.

David Colman will be in Lower Hutt on Friday 26 August and is planning trips to Whanganui and Palmerston North.

Please let us know if you would like an appointment.

Chris Lee & Partners Ltd


Taking Stock 4 August 2022

Chris Lee writes:

APPARENTLY leaked to the National Business Review, the details of Kiwibank's sale of its KiwiSaver business will be most encouraging to the shareholders of Kiwibank.

It seems that the Community Trust created to own the Taranaki Savings Bank (TSB), as the current principal owner of Fisher Funds, has bought Kiwi Wealth from Kiwibank for a price north of $300 million, a figure that highlights the richness of KiwiSaver fees (and all managed fund fees).

The sale will represent a huge bonus for the owners of Kiwibank.

What is effectively the TSB had bought Gareth Morgan Investments for around $55 million several years ago and has grown the KiwiSaver fund to the point where another manager has now paid more than $300 million to take over collecting of the annual fee income.

Morgan's success in selling his brand to Kiwibank had itself been a marvel, given that investment management was not how he earned his admired reputation. His management of personal risk was not from a risk/return assessment that would comfortably fit most people. Gareth's flight path through life has never been preordained. He is a champion, but unconventional.

Ultimately his funds management company grew beyond his expectation, requiring him to manage dozens of staff and hundreds of millions of client money. Morgan is not, by nature, a desk-based chief executive.

Wisely, he sold, effectively monetising his personal brand name.

Kiwibank grew the savings pool from hundreds of millions to multi billions and now has cashed up on what was obviously a triumphant foray into ownership of a contract to manage the money of people who vary greatly in their attention to their savings.

Years ago TSB and its Trust had acquired control of the Fisher empire built by the adventuress Carmel Fisher, itself an acquisitive company unafraid of borrowing to buy management contracts, its purchase of the damaged Tower brand bringing scale to Fisher Funds.

When TSB bought Fisher Funds it did so in partnership with TA Associates, based in Hong Kong.

The Asian appetite for funds management contracts is no less voracious than those in New Zealand. Hundreds of millions are made from trading in these contracts to manage other people's money.

By buying Kiwi Wealth from Kiwibank, the Fisher/TSB/ Hong Kong group now becomes a relative giant, with around $12 billion of KiwiSaver funds on which to calculate fee income.

This makes Fisher Funds comparable with the big banks and in terms of all funds under management, roughly half the size of Jarden, Craigs or Forsyth Barr, Fisher Funds raking in from captive clients hundreds of millions of fees each year.

KiwiSaver has been so lucrative for all those who capture the management contracts because once the retail saver signs up most savers never change their provider, irrespective of the often humdrum performance of the manager. Negative results seem to have no consequence. Some of the vessels now managing KiwiSaver have undistinguished, grasping helmsmen. Yet the new money gushes in, every week.

Very lightly regulated, KiwiSaver funds management is just about the living definition of a free lunch, especially for those who simply ape an index, something a chimpanzee could do.

Enjoying their lunch last year was NZ Funds Management, which claimed tens of millions of bonus fees for its small group of private owners.

It made a whirlwind profit from investing in crypto currencies. At the time bonuses were calculated NZFM was permitted by its client-approved management agreement to retain around $50 million in extra fees. When the investor returns turned south, in 2022, after a year of such hollow gains, the bonuses were not refundable. The rules displayed this process. My own view is that the ''rules'' are in urgent need of revision.

NZFM is principally owned by Gerald Siddall and Russell Tills, two of the principals in the dreadful First Step fund it developed alongside its partner, Money Managers, run by Douglas Lloyd Somers Edgar, two decades ago. First Step cost its investors tens of millions of capital.

NZFM as a fund manager is a tiny player acting quite properly and legally when it structured a high-risk fund permitted to trade in cryptocurrencies.

Its retail investors must have accepted and authorised its adventure.

NZFM receives its investor funds largely as a result of a cache of rewarded financial advisers who are authorised to sell such funds. Perhaps these salespeople included those trained in an earlier era.

Fisher Funds, by contrast, like Kiwi Wealth, largely does its own selling and, like NZFM, operates legally, benefitting from the scale of the operation.

As the market regulators gain in experience and resources, I expect there will be new attention given to the skills of all fund managers, given the sales process varies so much. I will applaud when I observe investors are understanding the details of the strategies they have accepted. Currently most KiwiSavers have no apparent interest in such details.

Theoretically regulatory supervision is adequate.

Theoretically, regulation of the 60-odd finance companies extant in 2006 was judged to be adequate.

I have very little respect for the value of trustees and auditors, who supervise.

As managers report negative returns, there may well be a new emphasis on risk and return, and on FMA supervision.

By selling Kiwi Wealth, the Kiwibank owners have dragged in a sum north of $300 million, presumably to add the book value gain to capital, enabling the bank to grow.

In rough terms $200 million of nett gains, capitalised, ought to enable Kiwibank to grow by a factor of ten times that sum. A book larger by $2 billion ought to produce around $50 million of additional surpluses to the owners, every year.

Meanwhile Fisher Funds will gain new income with very little increased administrative cost.

Inevitably there will be a hundred or more redundancies from Kiwi Wealth's team, the Fisher team able to cope with the additional administrative work. The Hong Kong partner will receive some nice, fat NZD dividends.

One wonders how many years will pass before the combined Fisher/TA/Kiwi Wealth group returns to the market, looking to sell at an even greater sum.

Would the next buyer be a Chinese bank, able to fund its acquisition with Chinese government money? The Chinese government love gold mines, especially those that are lightly regulated.

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AT the seminars held around the country two months ago, a frequently asked question was when the Bank Deposit Guarantee promise by Labour's Robertson would be implemented.

Many bank depositors were anxious to hear when the promises of Robertson and his colleagues would be effective.

We now have a clearer hint of timing, Robertson having indicated that the government scheme would be attached to other legislation scheduled for introduction around 2024.

Readers may recall Robertson promised the Labour government would guarantee a deposit with any bank, and possibly any similar deposit-taker, up to the extravagant level of $100,000 per person, per bank.

This might mean, if he was quoted correctly, that a couple could each put $100,000 in five different banks, enabling them to have $1 million of Crown guaranteed deposits.

Such largesse seems out of place with a government which regularly has mocked the wealthy, its late Minister Cullen, finding a rather crude way of addressing moneyed people, when he was describing Key in Parliament.

The number of New Zealanders with a million of cash to put into bank deposits would be less than one percent of the voting public and would be a group not expecting much help from the government.

There are at least two interesting aspects of this Labour promise.

The first is that it contrasts with long-held Treasury thinking that bank deposits should not involve a Crown liability given the Reserve Bank is tasked with ensuring the competent supervision of banks.

I am unsure whether deep within this Treasury position was an element of dislike for the RB's independence, something Treasury has been unable to achieve for itself. The RB is across the road from Treasury on The Terrace, in Wellington.

The RB's principal roles in New Zealand used to be controlling the money supply to keep inflation within accepted levels, and the supervision of banks, to minimise the levels of reckless behaviour, ensuring the banking system was resilient and functional.

The RB is today still fumbling with Robertson's new ideological directives, that it underwrites unemployment, incorporates a Maori perspective in its thinking, and takes into account the need to address climate change.

It has not yet been instructed to measure the hoof prints of cattle in wet, sloping paddocks, though there will be at least one Minister who might be seeking the right organ of government on which to impose this task.

Of course most adults will remember how the barely-supervised second tier of deposit-takers damaged the country in 2008.

The banking system survived, boosted then by tangible support from its Australian shareholders, and by the Crown's dreadfully-drafted, irresponsibly-supervised guarantee of all deposit-takers, including hundreds of billions of bank deposits.

We now all know that various plonkers in Cabinet, Treasury, the Reserve Bank, the Securities Commission, the NZX, and the Justice Department, allowed the guarantee to be exploited.

These same people, having set the fire, then allowed passers-by to extract billions of dollars of value from the Crown, exploiting some appalling decisions by receivers, the worst being with South Canterbury Finance.

Guarantees of deposits distort.

Today, the RB, led by an activist governor in Adrian Orr, is much less enamoured with the governors and executives at the banks, Orr having watched, from within, banking behaviour, earlier in his career.

He has loudly challenged the amateurish governance of ANZ and Westpac. Indeed if he had the power, I expect the banks would be required to use quite different criteria when selecting their head honchos.

Orr-supervised banks, if his style was unhindered by politicians, might indeed preclude the need for a guarantee. For one thing capital levels would be higher, and risk assessment more brutal.

The other issue arising from the guarantee is who would bear the cost.

Why would Robertson want to socialise any cost of investor hazard, given that it is these ''rich twits'' who would benefit the most.

An obvious response would be to price the guarantee, the cost taken from the interest rate, the depositor paying for the benefit, the bank simply a conduit of the fee.

Invest at 4% for four years in Bank XYZ, or accept a Crown-guaranteed 3.5%, eliminating the risk of default.

The cost/benefit would then rightly be borne by the investor.

If Robertson is still around in 2024, and his plan is implemented, one imagines he will by then have had sane advice and will not be offering yet another free lunch.

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Johnny Lee writes:

A SERIES of announcements from major New Zealand companies will have triggered alarm for some and relief for others, as our sharemarket prepares for reporting season to commence later this month.

The worst news came from bladder-cancer technology company Pacific Edge, as it responded to a proposed change in the way its tests are reimbursed from some providers in the US. The change relates to the coverage for tests reimbursed by the US Centers for Medicare and Medicaid Services.

Pacific Edge has, over the past several years, been expanding its US presence and reporting growing test numbers and revenue from that market. Although the company has not yet quantified the impact of the proposal, some analysts have warned that Pacific Edge's revenue could more than halve. It is a significant announcement that saw its share price fall more than 40%, wiping hundreds of millions from its market capitalisation.

Pacific Edge was at pains to reiterate that the proposed changes are in a draft form and therefore subject to change.  However, shareholders are ultimately the group that must carry this risk.

It was clear from the immediate market response that many investors have had enough, with the sell-down being fairly indiscriminate on price, as shareholders rid themselves of a stock that has had its fair share of highs and lows over the past two decades.

Of course, every seller must match a buyer. Those buying today at around 50 cents will no doubt be harbouring a hope that the proposed changes do not come to pass, or that the fears around its impact are overstated. Risk tolerances vary, as do investment horizons. The many false starts experienced by the company have rewarded traders more than investors, and those choosing to remain shareholders in the face of this proposed change are clearly accepting of the new risks in front it.

A2 Milk has also made an announcement, responding to media speculation that the company's infant formula product was to receive, this week, approval for its sale within the United States.

The US has experienced a temporary infant formula shortage over the past six months, after the closure of a key facility in February following a product recall. The US Government has responded by approving a range of global providers for import. Market speculation was that A2 Milk was to be added to this list, adding revenue during a time of downturn in certain Asian markets.

A2 Milk reiterated that approval has not yet been granted, but is being sought. There is also no certainty around how meaningful and long-lasting such revenue would be. Nevertheless, the market was happy to accept positive news and sent the price higher. One could expect the company's result announcement, due later this month, to expand on the potential impact of this.

Mainfreight provided another update to the market, with its first 16 weeks of the year continuing the fantastic run of results it has experienced over the past two years. Double digit – in some areas triple digit – growth is still being observed in the logistics sector.

While it would be true that these conditions cannot persist indefinitely, Mainfreight is clearly still enjoying a period of elevated margins and planning ahead for further growth. The company's growth ambitions – particularly in Asia – are very aggressive and supported by its excellent track record. Indonesia and India appear to be the next on its list, with dozens of other locations also being explored.

Barring a sudden reversal, November's result promises to be another strong one, perhaps beginning to justify the enormous share price gains the company has enjoyed over the past two years.

Lastly, Infratil's revaluation of LongRoad Energy further narrowed the gap between Infratil's share price and Infratil's underlying value, with the share price rising alongside the rising valuation.

LongRoad is a developer and owner of renewable (wind and solar) projects in the United States, and is part owned by Infratil. Infratil also has a stake in Galileo, a similar business in Europe, and large stake in Gurin, which targets Asian markets.

Infratil's share price performance, one of the best in the market, has nevertheless long trailed the underlying value of its assets, with many inside and outside the company believing the company to be undervalued.

Infratil will not spend all its time trying to convince the market it is worth more than its share price implies. Market forces should be determining this. Instead, it simply allows actions to speak in its place, Vodafone's tower sales and LongRoad's revaluation being two examples of the company proving its value for its shareholders.

The market continues to await the outcome of the RetireAustralia strategic review. This is unlikely to find a conclusion that will generate the same level of optimism amongst investors.

Infratil's half-year results will be released in November.

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Travel

Johnny Lee will be in Christchurch on Wednesday 24 August (Russley Golf Club).

Edward will be in Wellington on Thursday 25 August (Featherston Street); and in Auckland on 31 August (Ellerslie), 1 September (North Shore) and 2 September (City).

In September, he will be in Blenheim on Thursday 8 and Nelson on Friday 9 and in Napier on Thursday 22.

Chris will be in Takapuna on August 16 (p.m.) and has several vacant times in Ellerslie on August 17 (a.m.) and in Ellerslie on August 19 (a.m.). He has two available vacancies in Ashburton on September 7 (a.m.) and one in Timaru (p.m.) on September 7.

David Colman will be in Lower Hutt on Friday 26 August and is planning trips to Whanganui and Palmerston North.

Please let us know if you would like an appointment.

Chris Lee & Partners Ltd


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