Taking Stock 21 January 2021

THERE is an explanation for why New Zealand has more family trusts per head than almost any other country.

The truth is the trusts were mostly established to avoid or reduce tax, and to avoid the means testing that precedes the granting of social welfare, from the dole right through to rest home subsidies.  Trusts avoided death duties.

They continue to help avoid judicial interference with estates, trust structures foiling those who would contest what would otherwise be dictated by wills.

And, of course, they enabled professional people to hide assets that a creditor might target. But the prime explanation is that in NZ, where we have income-tested or means-tested social welfare, a family trust has been the most frequently used device to access a benefit that otherwise would have been unavailable.

Former National Party leader, and Prime Minister, Jim Bolger brought in a surtax to divert the NZ Pension away from well-off retired people, in the 1990s, a time of fiscal austerity.

The family trust thwarted his plan. That single event gave birth to more than 100,000 family trusts.

Lawyers, and various rogue organisations, like Money Managers, constructed complex trust arrangements, in so doing earning fat fees and circumnavigating political intervention.

But that was yesterday.

Today, most of those motivations to form a trust are falsely based.

Death duties are zero-rated (no tax payable). The rest home subsidy is approved, or not, only after examining family trusts, and other benefits examine all potential assets and income.  You can run but you cannot hide.

That leaves as legitimate motivations a few objectives, including asset protection from creditor claims, and the avoidance of judicial interference with estates.

That is where we are today.

Within weeks, the scene will have changed again.

New law, coming into effect next month, is targeting trusts, already under pressure from those who enforce anti-money laundering, who discourage trusts with endless disclosure requirements, including such matters as ''source of funds'', a declaration most often answered by the one-liner – bank deposits.

The new law will make it harder for the settlors of trusts (those with the money) to create a trust that exonerates trustees from the banal penalties that attempt to enforce ''conventions'' on funds investment, with many such intentions based on the big lie, that equity investments always grow over time.

Trusts must advise all beneficiaries of their existence. There will be no secrets.

A settlor can no longer stipulate that trustees can sidestep risks by investing only in asset classes like cash or fixed interest. And from next month all potential beneficiaries (eg grandchildren) must have their investment horizons and risk tolerance taken into account by trustees.

A trust which might have described one's spouse as the primary beneficiary might have commanded trustees to prioritise his/her needs and ignore potential beneficiaries until he/she should die.

Furthermore, from next month, trustees must regularly disclose to all beneficiaries the assets in the trust and discuss investment strategy, providing beneficiaries with an opportunity to complain, or even litigate.

There are no doubt some good intentions in this new law.  My preference would have been to authorise the defining of primary, secondary and tertiary beneficiaries, enabling trustees to prioritise the primary beneficiary, if needed.

My other preference would have been to abolish trust management companies, or failing that, require them to advise all beneficiaries of their plans and their costs, and to have a sunset clause, enabling a majority of beneficiaries to sack the trustee. Currently trust companies can milk trusts for as long as they like. And boy, do they exploit this.

I will explain my logic in the Taking Stock item that follows.

In general, trust management companies are fee greedy, have inappropriate ownership aspirations (focused on dividends and imminent sale) and have no ability to attract the sort of investment skills that would justify their role in funds management.

The new law should have addressed these issues.

Sadly, as was the case with the Insolvency Practitioners Act, those who conjured up the law had far too little contact with those who pay for the service. The Old Boys Network has had another victory.

The focus was on those who benefit from the law.

As a result, the only remedies now lie in the registration process that leads to licensing of trust managers, and the much tougher use of the fit and proper person assessments by the regulators.

The Public Trust would be the closest to a credible organisation in the sector though it, too, has had dark periods of atrocious leadership and ham-fisted policy.

The ape in the trust jungle is Perpetual Guardian, an organisation with a short history, though its origins, Perpetual Trust, NZ Guardian Trust and Covenant Trustees had their own histories.

None were respected. Some of their behaviour had been appalling.

Amalgamating three disrespected, poor performing trust companies was hardly a formula likely to lead to any shade of excellence.  Indeed, the transaction aspired to flog off the new group, before mezzanine borrowing costs began to bite.

My advice, as will be in part justified by the next item, is to use the Public Trust if one must use a trust company, but preferably never to use any trust company, if you can find a lawyer or family members who would apply the new laws cheaply and without self-focus.

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REGULAR readers of Taking Stock may recall that last year I recorded a dispute over the fees, and the skills of the staff, of Perpetual Guardian.

While walking the beach during the April Covid lockdown, I took a cellphone call from a woman who had become distressed by Perpetual Guardian's management and charges.

Unwisely, her mother had been persuaded to appoint Perpetual Guardian to act as executors of her estate.

She had died, leaving behind a modest family home and around $30,000 of bank deposits, instructing that these be cashed up, any incidental dues be paid out, and the residual amount to be split between her offspring. The total involved was around $430,000.

These simple tasks, somewhat slowly, had been performed, with modest skill, without adequate communication, and at ridiculous expense.

The big issue was Perpetual Guardian's charges.

Perpetual Guardian's website confirms it is by far the most expensive trust company, and if all websites were forced to display complaints, it might also confirm it has been what I might politely call a controversial service provider.

The woman who rang me told me that Perpetual Guardian had charged around $65,000 including GST for their role in appointing a real estate company to sell the home, collecting those proceeds within a few months, retrieving the bank deposits and storing them before disbursing them to the beneficiaries of the estate.

With apologies to her, I must record that originally I did not believe the story.

Having been involved often in such transactions, I knew the standard rate might be around 2% of the estate's $430,000 value, say $8,600, plus GST. A charge of $65,000 sounded like fiction, or a typing error.

I rang a friend in the Public Trust to confirm my knowledge. They confirmed the fee would be around $10,000.

I rang the co-owner of Perpetual Guardian, Direct Capital.  Its managing director, Ross George, graciously agreed to poke his nose into the minutiae.  He is a decent man.

He confirmed later the figure and, to the extent that a non-executive business owner can intervene, he sought to help, but no refund of this impost was offered.

PGT's senior person in charge of the case was unbending.

So I advised the angry woman to contact the disputes resolution company, Financial Services Complaints Ltd, an organisation run largely by empathetic, wise women, quite independent from the companies like Perpetual Guardian, which are forced to pay them to resolve the complaints of unsatisfied clients.

To cut to the chase, after several months of unpleasantness, Perpetual Guardian has apologised, returned a chunk of their absurd fees, and the senior person who resisted the complaint is pursuing a new career, presumably still believing a charge of some 15% of the estate's assets was justified.

I could easily stretch out this article by itemising many other disputes with Perpetual Guardian that have been referred to me, usually at the suggestion of lawyers.

Some have been resolved to avoid public discussion, some have yet to be resolved.

I could also discuss the hundreds of dreadful examples of incompetence that occurred during the finance company bonfire, where Perpetual, NZ Guardian Trust and Covenant were almost wilfully incompetent, obvious victims being those who invested in Lombard, Strategic, St Laurence, Hanover, Bridgecorp and Dominion Finance.

Those who were supervising company trust deeds displayed the intelligence, inquisitiveness and courage that one might expect from an ancient Egyptian mummy.

Reader ennui may legitimately discourage my reciting evidence of such appalling behaviour, leadership being invisible, skill levels displayed at primary school standards, rich rewards offered to people whose personal achievements deserved only clerical-type remuneration.

Suffice to say that the trust company model, always threatened because its foundations were built on a fault line, was shattered years ago.

Only its involvement with the nauseating Old Boys Network of greedy law firms, big banks, greedy liquidators and receivers and lazy regulators has allowed the trust company model to persist.

Who will be the disruptor that applies euthanasia to this network?

Will it have to be the great manufacturing disruptor, Nick Mowbray and family, to find a way to move us into the 21st century?

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THE elevation to the stratosphere of the share prices of Meridian Energy and Contact Energy has been so well explained to the media that no one should now be wondering what caused these pricing anomalies.

Foreign Exchange Traded Funds were committed to buy, at any price, a large number of shares in Meridian and Contact. Naturally they were gamed by real fund managers and serious investors.

When the funds telegraphed their robotic buying intentions, alert people bought as well, and then sold at higher prices each day, until the index fund buying programme was replete.

I guess this exploitation was a legal and moral version of the old, outlawed model of front-running that attracted dishonest and weak people – cheats – in the 1990s, one well known example leading to a young man disgracing his family, and having to be fired, eventually to reappear in an organisation that forgave such people.

Today there is nothing illegal or immoral in reading the covenants of passive or robotic index fund managers and positioning oneself to exploit their braindead model.

If I told a house seller that I was compelled by law to buy his house next week what do you think his price would do? No buyer would be so stupid.

The concept of such robotic funds is commercially naive.

The short-term price rise was nice for all who benefitted.  Indeed the buying in the future might continue at even higher figures if the US public continue to pour money into those robotic funds.

What this event did also uncover was the futility of any campaign to include passive fund managers in private boardroom conversations on strategies or tactics.

Here in New Zealand one of those mice that roar had publicly complained that the passive fund he founded was not winning airtime with public company boards. His phone calls were not being answered.

On subjects he wanted to discuss, putting forward his somewhat irrelevant musings, he was being ignored.  He wanted support from real fund managers who he wanted to see behaving like activists, demanding that companies in which the real fund managers invest, be open to hear the views of those with the power to invest or not invest.

As the Meridian/Contact transactions displayed, the robotic managers were going to invest at any price because they were compelled to do so by their own trust deed and covenants.

Whether they liked the strategies or tactics of Meridian/Contact or whether they disliked those plans, they were obliged to invest.  Why, therefore, would Meridian or Contact offer such people any time at all?  Such business models are leeches, not scorpions.

Further the Meridian/Contact people would be absolutely right to assume that a robotic fund manager need not have the faintest clue about any strategy or tactic.  Such a buyer is not an analyst, a researcher, or even a thinker. He is much more likely to be a salesman.

Whereas a real fund manager requires street wisdom, knowledge, experience, and relies on research, an ETF or passive fund just buys and sells, its rules pre-determined and telegraphed.

Of course its deed and covenant had once to be written but it cannot then be adjusted each day to take account of the whims of its irrelevant administrators and salesmen.

In New Zealand we have had countless examples of passive funds being gamed.  Synlait Milk's share price rise (to $14) was singularly the result of index buying, just as its fall to a current $5 has been at least partly the result of index weighting changes, resulting in selling.

The administrators who run index funds cannot have it both ways.  They are cheap, because they have no value to add, no relevant skill to sell.

They can hardly be expected to arrive without credentials or credibility at a boardroom door and expect to be regarded as an essential element in strategy-setting.

As a matter of scale, a passive KiwiSaver fund in NZ with $2 billion of other people's money to invest by rote will have around $400 million (at most) to invest in the NZX-listed companies.

The NZX market cap is around $200 billion, meaning that $400 million is one-fifth of one percent of the market.

It is hard to imagine any sizeable company being so time-rich that they would meet with any such roaring mouse.

By comparison, broking firms like Craigs and Jarden probably have the power to invest tens of billions into NZX companies. Their analysts would be entertained carefully by most listed companies.

If you add Milford, Fishers, Harbour Asset Management and the like, you might find a small number of people who can access boardrooms, because of their buying power.

And we cannot overlook the small matter of insider information! The likes of Craigs and Jarden would have very strict protocols to avoid criminal offences, like misusing inside information.

Passive funds obviously have their place in the financial markets. They are cheap.

But they are very different beasts from those with the access to the inner corridors, for a very obvious reason.

The Meridian/Contact Energy index fund behaviour underlined this limitation.

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Kevin will be in Timaru on 12 February.

Johnny will be in Christchurch on 4 February

Edward Lee will be available in Albany on 28 January, in Nelson on 3 (now full) and 5 February and in Napier on 11 and 12 February.

David Colman will be in Lower Hutt on 2 February.

Chris will be in Albany on Feb 9 and in Christchurch on February 16 and 17.

Please contact our office for an appointment.

Chris Lee

Managing Director

Chris Lee & Partners Ltd

Taking Stock 14 January, 2021

Chris Lee writes:

NO ONE would allege that the New Zealand Stock Market reflects underlying economic conditions and current business performance.  Such an allegation would be as risible as a claim that a country like New Zealand relies on its progress on the strategic wisdom of its political leaders.

Of course New Zealand has no strategy, has not had one for decades, and accordingly its plans are haphazard and usually managed on an ad hoc basis.

The NZX is often quoted as a measure of the country's economic progress but such a claim is fanciful.

The New Zealand share index simply reflects prices, not value and, as we all know, prices are today determined by the (static) supply of purchasable shares and the (flooding) volume of demand, from index fund managers, Kiwisavers, new investors and those investors who look for value and consider the underlying economic conditions.

By the end of 2020, the flood of money was coming from overseas, and from the Government's printing machine.

Prices rose.  Values fell.

For 2020, a year when value was undermined by a pandemic, the NZX index rose by nearly 14% from day one to day 365.  In March, it fell 30%.  By December that fall was irrelevant, yet few companies reported better net revenues. Some cancelled dividends or reduced them.  Some acknowledged headwinds (ATM, AIA, AIR as examples).

Remarkably, consumers ignored the underlying employment threats, ignored the reduced hours, ignored the social risk of growing inequality, of housing price absurdities, and ignored the imminent costs of new laws aimed at reducing climate change.

Instead consumers binged, emboldened by the house price rises which made them ''feel richer''.

To make it clear, the NZX rise did not imply rising value, nor did it imply an improvement in our economic and financial prospects.  It simply implied that index funds and fund managers generally were receiving unimaginably large sums of investment money and using it to buy New Zealand shares using a buying formula that had nothing to do with value.

There was no better example of this than when someone in some part of the world dreamt up a new index fund that would invest only in ''green'' electricity providers.

Meridian and Contact Energy were named in the index and nominated to receive 5% each (roughly) of the money submitted to the manager of this new index fund.

Money poured in.  The index fund manager honoured his promise and bought AT ANY PRICE Meridian and Contact Energy shares.  Those who already owned the share knew the index fund had to buy a large number of these shares.

They simply withheld their shares until the bidding reached a level that no sane purchaser would have paid.

Contact Energy shares, barely $5.70 a few months ago, hit $11, yet the company had not had improving profits, a soaring dividend, or even better prospects.  What had this to do with value?  Nothing.

The NZX rose because some index fund somewhere was spending other people's money by rote.

My view remains that as a genre, robotic investing is a modern-day danger to sane market pricing.

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THE appearance on the New Zealand stock market of Radius Healthcare will have jogged the memory of the many older investors who were active in the days when financial markets were unprotected from selling chains.

One hopes that as we begin 2021 with far more than enough crevasses to avoid, we never again allow the breed of wide boys that promoted Radius Healthcare in the early 2000s.

At that time Reeves Moses, Money Managers, Broadbase and Vestar were all unregulated, allowed to promote investment products that today would not just fail to pass muster, but would probably be shot on appearance.

Radius Healthcare, then a fledgling third tier rest home aspirant, known as Radius Care, succeeded in gaining the support of Kelvin Syms, who founded the selling chain Vestar, after an earlier link to Doug Edgar at Money Managers.

Virtually every portfolio of a Vestar client would include Bridgecorp and Capital + Merchant Finance. Apparently these companies had negotiated special brokerage rates with Vestar.

And virtually every portfolio that I saw included Radius Healthcare, which must have offered some sort of security – a share, a preference share or some sort of debt instrument – to Vestar clients.  Perhaps those Radius instruments were repaid or have converted to the shares that we now see on the NZX.  If that is the case, there would be several hundred ex-Vestar clients who would be greatly relieved to have avoided the fate of their Bridgecorp and Capital + Merchant Finance debentures/ notes/ preference shares.

Radius Healthcare has continued to acquire small rest home management contracts, often leasing the facilities from the property owner, making Radius more of a care manager than a property company.

In some ways, the Radius history is similar to that of Metlifecare, whose origin was a group of disparate and tired rest homes, acquired by Cliff Cook.

Cook managed to find support for an NZX listing in the 1990s.

Whereas the Metlife shares soon collapsed to barely half their issue price, leading to an enquiry into the listing, the Radius Healthcare listing did not attempt to raise money, instead taking the much more opaque route of a simple share listing, providing liquidity for its existing shareholders.

Those now buying the Radius shares on the secondary market are not being required to wade through sheaths of disclosure papers and are simply subject to the same ''buyer beware'' process of any other secondary market buyer.

The NZX would have conducted the due diligence that would have preceded Radius Healthcare's appearance on the bourse.

The pricing of Radius was itself interesting.

The directors accepted a valuation of 80 cents per share, its lawyers accepted an allotment of shares at this price, presumably for the legal costs involved in the listing, and the shares were then priced by ''the market'' on the debut day.

That listing price was momentarily more than double the price the directors had indicated was fair.  Early buyers on the NZX clearly believed they had a better understanding of the value of this care operator, by now a survivor in a sector that is dependent on the Crown pricing of aged care services.

Radius Healthcare is not even remotely similar to Ryman, Summerset or Oceania, all of which are property owners and care providers, whose care services are effectively subsidised by real estate and development margins.

The other listed vehicle, Arvida, is in halfway land, like Radius a small player in the big cities, but in Arvida's case, aspirationally a property owner in Auckland.

Indeed, Arvida has succeeded in moving towards the second tier and has recently enjoyed funds management support, one large Auckland fund manager appearing as a 5% shareholder.

Radius will remain in the third tier of its sector on the NZX.

But if any of the original shareholders from Vestar's kennels can now liquidate their Radius shares, then the listing would be welcomed by some.

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THE link between Radius Care, Radius Healthcare and Radius Properties has always been interesting, with the common figure of the Care and now Healthcare brand being Brian Cree, a white bearded fellow who must have been close to Vestar.

Radius Care bid for the properties it had leased from Radius Properties but was at least for a while thwarted by an outside party, Montague Investments, a company owned by Sandy Maier Junior and his American wife.

Maier, of course, was the Forsyth Barr selection to untangle Allan Hubbard's wealth in a bid to restore South Canterbury Finance, and was the American character who chaired Geon Print, which had somewhat oddly sought to dominate the printing industry, at a time the industry was entering its dusk.

As all these Radius companies have always been unlisted, deep research would be required to work out how the Maiers and Cree resolved their disputes of the property ownership.

Even if Radius Healthcare had been required to detail its history it is doubtful that the events of the Vestar era would need to be disclosed.

To my knowledge, there are no institutional investors in Radius Healthcare nor does Cree seek that sort of endorsement.

The Maiers would have long retired, Sandy Maier Junior having exited his Nga Tahu board role, now 70, living on a Hauraki Gulf island.

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THE pre-Christmas listing of the matrix, internet moneylender Harmoney, attracted criticism after its share price fell by around 30% from the issue price for a few days, before recovering.

Personally I was not an investor, not satisfied that algorithms will prove to be a long-term equivalent of experienced banking judgment.

Harmoney will argue that its source of money to lend will come from banks, meaning that any loose lending or bad results will be overseen by real bankers.

I accept my view is unfashionable.

If Harmoney can produce dividends for its shareholders of around 25 cents per share, then it will attract ongoing investment attention at its current price of around $3.00.

It should have little trouble in out-performing those unwise index funds that are choosing to lend directly rather than use bank deposits to meet their obligations to assign funds to fixed interest.

Index funds, driven by salesmen, or for that matter by any person without a genuine history in banking or managing Other People's money, will achieve a modern miracle if they succeed in side-stepping bad debts. They should adhere to their origin – mirroring the indices created by transactions that are driven by the research of better-qualified people.

Harmoney, effectively supervised by its bankers, has a chance to lend sensibly.  Index fund direct lending has much less chance.

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WATCHING the decision making of our major banks has always fascinated me.  Blowflies choose their flight paths with more consistency than banks determine their lending patterns.

For most of 2020, there were very few buyers for farms of any sort in the bottom half of the South Island, bankers being driven by politics and by irrational fear. Critics of farmers were poorly informed and failed to acknowledge the rapid improvements in farming practices, while milk prices were being forecast pessimistically.

On one of my visits to the South, farmers told me that unofficially as many as a third of all South Island farms would be purchased by any cash buyer, because of all this negativity.

How times have changed.

Banks are now more discerning, ASB is no longer in what seemed a crazed rush to reduce agricultural exposure, Rabobank seems to have adjusted to its obvious over-exposure to dairy, and the best dairy farmers have bought out their neighbours, confident that the milk pay-out will be thoroughly satisfactory and that Parliament will rethink some of its bizarre plans.

All of these might suggest that the listing of a fund to buy agricultural land at distressed prices has arrived a few months too late, prices again on the rebound.

The NZ Rural Land fund listed in December, having scraped past its minimum subscription level, its coffers barely half full, but promising to tap the market again, perhaps in 2021.

The fund does collect generous fees paid for by its investors, but at least it is transparent and will be subjected to much greater scrutiny than many of the fund managers who reap their profits from Kiwisaver and their other managed funds AND rake in their ''bonus'' fees, to ''align their interests'' with investors.

How bleakly does that assertion expose the self-focus of fund managers.

Does it not imply that without such bonuses the fund managers' rich fees would not be enough to extract a total commitment to their clients?

NZ Rural Land will now offer a vehicle for those non-farmers to participate in land price inflation.

One hopes that the driver of price increases will be land usage improvements, that are visible in different areas but rarely displayed in the media.

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Kevin Gloag will be in Christchurch on Thursday 28 January and in Timaru on Friday 12 February.

Edward Lee will be in Auckland (Albany) on Thursday 28 January and in Remuera on Friday 29 January. He will be in Nelson on Wednesday 3 February and in Napier on Thursday 11 and Friday 12 February.

Johnny Lee will be in Christchurch on Thursday 4 February.

Chris Lee will be in Auckland on Tuesday 9 February and Wednesday 10 February, and in Christchurch Tuesday 16 February and Wednesday 17 February.

If you would like an appointment to see any of our advisers, please contact our offices.

Chris Lee

Managing Director

Chris Lee & Partners Ltd

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