Chris Lee & Partners Ltd

Taking Stock 26 September 2019

 

Chris Lee writes:

Twenty-five years ago the group of New Zealand corporate leaders who called themselves the Business Roundtable were a mildly effective lobby group.

They were granted the privilege of being viewed as spokesmen for serious business, though there was no democratic process in their elevation to the moderate status of being Roundtable members.

Wisely, they excluded most yahoos whose business principles were devised solely to the personal pursuit of having more trinkets than their neighbours.  Only a few such slobs ever were asked to join the lobby group.

However eventually the Business Roundtable members dispersed, perhaps the victim of unadoring media and political comment, the likes of Ron Trotter denied a forum to display his undoubted nous.

Accordingly, I was surprised to hear that today the US has a Business Roundtable, comprising 150 business leaders with aspirations to bring about change.

I was even more surprised to hear that they wish to change the direction of US business leadership, urging new leaders to adopt the extraordinary, presumably recently invented, concept of building businesses on a ‘’sustainable‘’ platform.

Perhaps they had been reading that more than half of US businesses are falling stars, here today, gone within a year or two, and that most corporate governance is calibrated on the next quarter’s results, revenues, profits, share prices, dividends and, especially, executive bonuses.

I have written before of the senior Vice-President of a huge US bank who, at a bankers’ cocktail evening in New Zealand, was asked how long he had worked at the bank.

‘’Eighteen quarters,’’ the crass banking pretender answered.

That the US Business Roundtable now wishes to drive a ‘’sustainability’’ campaign is not bad news.  It is wearying, however, to infer that this concept is innovative and newsworthy, rather than mundane.

Short termism drives some of our bleakest social ailments, such as inequality, excessive use of debt, and environmental pollution (climate change being a potential eventual outcome).

Sadly we still see short termism in New Zealand.

Our worst corporate giants are deemed by many to be the major banks, Fonterra and Fletcher Building.

All have been flailing about in an ocean of greed and short termism.

Anyone who wants to debate the presence of the banks on this list should read ‘’Banking Bad’’, a non-fiction book based on the behaviour of Australia’s banks, with a crucial reference source being the Hayne Royal Commission report on Australian banking.

The book is reviewed as being an account of bullies, thieves and crooks, written by journalist Adele Ferguson.

I shall not ruin the plot by paraphrasing it here but just one example is worth quoting.

The CBA and Westpac both designed totally inappropriate bank products, rather like the ING High Yield funds in the early 2000s, that were aimed at leveraging high-yielding securities, producing high returns for high risk.

Why was that an unsuitable banking product?  The answer lies in the expected culture of the bank, customers entitled to believe that banks are there to receive one’s capital and return it intact.

High risk, high return ill fits that culture.

Ferguson, by reading the Hayne report, learned that in very recent times CBA and Westpac paid specific incentives to tellers ($400) for each client referred to a ‘’financial adviser’’ in the bank, to sell the high risk product.

The ‘’adviser’’ was paid around $2,000 if he could persuade the referred client to borrow from the bank to speculate in this fund.

The ‘’lender’’ was in turn paid more thousands in bonuses to convert the client into a borrower, accepting a bank loan to provide funds to be put into the fund.

The bank would take no capital risk, the staff would bastardise their jobs by flogging off a dubious product, and the hapless client would take all of the risk of receiving returns from a fee-hungry product.

In other words the bank was risking client wealth and its own reputation by pursuing the short term gain of more revenue (more bonuses, more dividends).

Perhaps all of this illustrates my view that the Australian banks have been seduced by tinsel, glitter and fairy dust, rather than the substance that ensures sustainability.

In my opinion banks should be chaired by people with substance, with banking knowledge and with social responsibility.

The late Sir John Anderson led and later chaired the ANZ/National Bank. He was revered by his clients and staff because tinsel meant nothing to him. Teflon was a fake concept. He valued substance and sustainability and accountability.

Fonterra and Fletcher Building need to face the same issues.

All of the corporate world will recall how in recent years Fonterra mis-valued its investments, effectively allowing dividends and executive bonuses to be paid, rather than confess the investment errors and take responsibility. The FMA is still investigating the audit of Fonterra.

Fonterra grossly overpaid its executives, who were essentially appointed to run a virtual monopoly, collecting milk, selling it or a refined version of it, and borrowing money from banks and others because the payment to the suppliers of the milk could be subordinated behind the obligations to those who lent Fonterra money.

Running Fonterra, and designing milk-based products that suited the different palates of the world, was not quite as simple as shooting rats in a barrel, but very few areas of Fonterra needed highly-skilled people like scientists and engineers.  Anyway, the sales force swanning around the world were the overpaid, and over-glorified, not the scientists whose work underwrote the standards (of hygiene, etc) upon which sales depended.

At Fonterra 17 people in 2018 were paid more than a million a year, 6,000 were paid more than $100,000 a year.  Fonterra employed nearly 20,000 people.

Fonterra has racked up massive losses, and currently has quite properly suspended dividends, as a result of investment decisions made years ago that were, shall we say, misguided and unwise.

In the context of NZ, a group of 17 people within one company being paid more than a million a year might have been expected to comprise somewhat wiser and more insightful people than Fonterra attracted.

Its culture was lousy, its belief in its status and entitlement quite at odds with most of its dairy farmers who work with passion to maintain milk supply from their herds.

Thank heavens that right now Fonterra has the odd director who understands the need to reform Fonterra’s culture and recalibrate its governance.

Fletcher Building was an accident waiting to happen, going back decades to an era of the supercilious leadership of Hugh Fletcher, whose contribution to the company’s performance was not measurable in value-accreting projects.

In recent times the crass UK investment banker Mark Adamson oversaw a prolonged period of poor decisions, grossly overstated the value-add of his overpaid executive team, and presided over a decay in culture at Fletchers that destroyed investor respect.

Ralph Norris, who was the CEO of CBA bank, was later the chairman of Fletchers, an unusual quinella in the eyes of some, a trifecta if one includes his governance and executive roles at Air New Zealand during a bleak period of its history.

Thankfully, as is happening with Fonterra, the new leader, in Fletcher’s case Ross Taylor, seems to understand that millions, hundreds of millions, should not be regarded as ‘chump change’, as one show pony once told the media.

Wastage leads to a culture that eventually accommodates staff theft, bribery, and other displays of immorality and illegality.

Such outcomes destroy sustainability just as they destroy respect.

The Australian banks, Fonterra and Fletcher Building directors and executives should head down to Paper Plus and buy ‘’Banking Bad’’.

How absurd that we need to teach the Old Boys Network that their role is to ensure value-add and sustainability, not to speak of morality and leadership.  Ferguson’s book deserves a wide audience.

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Increasingly, investors can find solace in the intentions of the Financial Markets Authority leaders, especially Rob Everett and senior counsel Liam Mason.

Everett has been asked to consider reverting to the laissez-faire policies of some large countries, allowing directors to shroud their announcements without fear of sidestepping specific continuous disclosure obligations.

It is still inexplicable that in NZ the likes of South Canterbury Finance, effectively owned by our government after the Crown guaranteed a demonstrably insolvent company, were allowed to hide their problems, while trading in the securities continued, hapless investors simply ripped off by all those who secreted the truth..

At the very least such securities should be suspended from trading while there is no symmetry of information.

Even more inexplicably, our capital markets are seeking permission to dilute the value of continuous disclosure.

Happily the FMA, and Everett in particular, have made it clear that our regulators have no wish to abandon the tight oversight of disclosure as is practised in Australia.

It seems to me that our main regulators, the FMA, the Reserve Bank and the NZX are now much less likely to accept the sort of chicanery that led to South Canterbury Finance’s billion dollar wealth destruction. I cannot understand why so many incompetent people have never been removed from the ‘’fit and proper’’ group who are permitted to lead our capital markets.

The NZX now has a much more appropriate board and chief executive, the FMA has removed its mouthguard so its teeth can be displayed, and the Reserve Bank has a governor who feels no obligation to any Old Boys Network.

Hooray! We may yet reach a level of behavioural standards that bars poor performers.

 _ _ _ _ _ _ _ _ _ _ _ _

Johnny Lee writes:

When one chooses to make an investment decision, return for risk should be at, or close to, the top of one’s decision making process. Focussing on only one aspect can expose investors to inappropriate levels of risk, or an insufficient return on the money at risk.

To assist investors in making accurate decisions, we have rules and regulations surrounding investment products to ensure information is conveyed in an accurate manner. One such law governs the advertising and description of products to ensure they are not misleading. Nevertheless, investors should be careful to ensure they fully understand the nature of the investments they make, or consult an advisor who can assist with this.

The recent public marketing and subsequent NZX-listing of the ‘Private Land and Property Fund’ (PLP) by Booster Financial Services, formerly known as Grosvenor, gives investors access to a unique product, and an opportunity to profit from the ownership of a very small number of vineyards in Marlborough, Nelson and Hawke’s Bay, and a single orchard in Kerikeri, purchased from and leased back to Seeka.

The fund is modest in size, and accordingly offers little in the way of diversification. This may change over time, as the fund intends to invest in more diverse assets over time. At present, the fund gives investors the opportunity to invest in specific horticultural and viticultural land, and profits from long-term leases, and the supply of grapes to wineries.

The fund does not own wineries. This is a key point – investors that may normally be put off by the extremely competitive nature of the wine industry should remember that the fund invests in the land – which naturally incurs very long-lease terms.

One of the leaseholders is in fact the Booster Wine Group – which is owned by Tahi Investments, another Booster product. The hard-working staff at Booster can probably deduce what the annual Christmas gift to staff will look like.

The more bibulous investor may see such an investment as justification of their indulgence, however investors would be wise to fully consider the risks associated with the investment. It is not, nor comparable to, a term deposit at the bank.

It’s difficult to tell where the bizarre comparison to a term deposit originated from.  It was not helped by a comparison chart displayed on the Booster website, outlining the various advantages and disadvantages of the two products.

I suspect such a comparison was designed to help educate potential investors about the key differences between two completely unrelated investment opportunities, but instead led to headlines that Booster were aiming to ‘capture NZ’s term deposits’. The team at Booster will not be trying to mislead the public into thinking the two are somehow comparable.

Disclosure obligations requiring Booster to disclose its estimated operating fees also serve to muddy waters. The management fee charged by Booster is 1%. Most of the additional fees that are disclosed relate to estimates on fees incurred, rather than fees earned by the manager itself.

Listing the fund to market, as is the case with the Smartshares products, helps remove some of the concerns investors might have regarding illiquidity. If an investor wants to exit their investment, they can simply sell their units on the open market – assuming a buyer exists.

This approach is likely to be replicated further, as more funds look to the market as a way to invite further investment and liquidity.

Our preference, as advisers, has always been listed managed funds, rather than the unlisted model.

The PLP Fund will be best suited to a very specific type of investor. The forecast returns seem modest, and the relative youth of the fund may warrant caution. Nevertheless, the fund provides access and liquidity to a type of asset that can be difficult to invest in, while removing some of the disadvantages of owning such an investment.

TRAVEL

Edward will be in Wellington on 10 October & Auckland (Remuera) on 16 October.

Kevin will be in Christchurch on 17 October.

Chris will be in Christchurch on Tuesday 15 and 16 October, the timing clash created by unchangeable commitments.

Johnny will be in Christchurch in November, dates to be advised.

Chris Lee

Johnny Lee

 

Chris Lee & Partners Limited

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Taking Stock 19 September, 2019

Johnny Lee writes:

The Capital Markets 2029 group has reported its findings to the public, which include recommendations ranging from sensible ideas to bold ambitions, while including some fairly contentious stances worthy of debate.

It is worth reading.  It represents the collective ideas of a range of market participants - from fund managers, brokers, advisers, accountants and bankers - on what changes are needed to improve and stimulate our capital markets.

Unsurprisingly, the bulk of the document deals with Kiwisaver, regulation and tax – probably the three biggest ‘levers’ that could influence investment in capital markets.  There are also some suggested regulatory changes, intended to make it easier to grow the sector.

In the Kiwisaver space, asset allocation seems to be the key focus.  Kiwisaver investors hold about a fifth of their balances in cash or cash-like instruments.  A further third is in fixed interest.  Readers of this column will know the sorts of rates fixed interest products are currently returning.

This breakdown might make sense if you want to guarantee the value of your investment for an imminent withdrawal, perhaps for a house or retirement.  It might also make sense if you were anticipating a near-term downturn.

It makes less sense for the three quarters of members, below the age of 50, to hold such a large proportion of low-yielding assets.  This could be a testament to New Zealand’s famed risk-aversion, or a preference for physical, tangible assets like property.

The report highlights the structure of Kiwisaver as exacerbating this.  Investors can, at short notice, change Kiwisaver providers, or change schemes within a provider.  This forces every Kiwisaver provider to maintain an additional level of liquidity they may otherwise not wish to hold.  It also hinders funds investing into illiquid investments, or assets with no liquidity at all (such as private, non-listed companies).

Under current settings, some liquidity will always be required, as people withdraw to buy a house, move overseas or reach 65 years of age.

The suggested solution to this is to allow investors to invest across multiple providers – potentially even self-directing their investments - the latter idea intended to transfer that liquidity risk to the investor themselves.

The liquidity risk refers to owning assets with an uncertain value, which may not be readily transferable into cash.  A Kiwisaver provider is unlikely to invest in a South Island gold mine – no matter the returns – if they cannot identify a way to exit the investment at short notice if the Kiwisaver investor chose to switch providers.  Furthermore, the hypothetical gold mine does not want investors that may withdraw at short notice.  If a greater proportion of our savings are to be tied up in Kiwisaver, the settings may need to be changed to account for this longer-term thinking.

Investors change providers or schemes for various reasons.  Some may wish to take more (or less) risk, and shift from Conservative fund types to more aggressive Growth funds.  Those who have done so have seen enormous paper gains to their portfolios.  The risk was rewarded.

In Market News on Monday we touched on the use of different fees as a possible method for increasing term commitments, giving fund managers confidence to invest in less-liquid, long-term investments.

However, billions of dollars remain in Cash or Conservative funds.  To me, this illustrates a lack of effort among the financial advice community, fund managers and the media to assist people in understanding risk profiles and returns.

_ _ _ _ _ _ _ _ _ _

Another recommendation made by the group is to create an amalgamated AML (Anti-money laundering) Register – one accessible by all parties.  This would absolutely improve the life of every market participant.  It is also extremely unlikely to ever happen.

It would be safe to say that neither banks nor brokers receive enthusiastic support from the public when it comes to enforcing AML/CFT (Countering Financing of Terrorism) obligations.  Collecting and verifying passports, addresses and ‘sources of wealth’ are not likely to be tasks that either party conducts with ebullience.

The lack of consistency across various participants is also noted in the report.  For some, a scanned or faxed copy is sufficient.  Others prefer originals.  Some accept driver licences, others want passports.  The idea of one simple register, where documents are held and can be shared by client request, would save both time and frustration.  Suggestions these be made available across Australasian borders sound even more appealing.

However, such a transition would require substantial development and investment, in an environment where certain key stakeholders seem extremely reluctant to ‘rock the boat’.  The incentive for these stakeholders to instigate such sweeping changes seems non-existent.

Another recommendation made by the group surrounds the subject of continuous disclosure.

At present, when a company becomes aware of material Information, it is required to release it to the market through a prescribed means.  Material information, in this context, simply refers to information that a reasonable person would expect to have a material effect on its share price.

There are exceptions to this obligation – for example, if releasing the information would breach the law.  However, the principle that shareholders (owners) of companies deserve to know information, at the same time as everyone else, is sound.  Some investors will have seen instances in the past where share prices have moved dramatically, on large volume, only to see an announcement to market a few days later.  This is normally attributed to insider trading, which is a consequence of asymmetric information from improper disclosure and information handling processes.

The point the group raises is whether intent (either reckless or dishonest) should be considered.  If a company errs in failing to disclose information, through no deliberate fault of its own, should the company in turn be fined, and its shareholders effectively punished by proxy?  The fines involved would be significant for smaller firms, and can be in the hundreds of thousands of dollars.

The opposing argument – of course – is whether it should be the obligation of affected parties to prove the reckless or dishonest intent of a company when they fail to disclose such information. Proving this may not always be straightforward.

Other recommendations, around changing tax treatment of savings, improving financial literacy among young people and simplifying the IPO process for new listings, are all fairly mundane and should not generate controversy.

Ultimately, the report may end up effecting very little change.  Many of the recommendations would require law changes, and the Minister responsible, Commerce Minister Kris Faafoi, responded almost immediately to the report with a fairly blunt response, stating ‘there’s a lot of recommendations’ and the Government is ‘pretty busy’.  There does not seem to be much willingness within the Coalition Government to commit to examining the issue further.

In the absence of political will, it seems the Group’s work will largely go the way of the Tax Working Group’s report – which detailed the recommendation regarding a capital gains tax – providing scrap paper to those interested enough to print a hard copy.

_ _ _ _ _ _ _ _

Two announcements released to the market last week caused big swings in their respective share prices – being Z Energy and Synlait Milk.

Synlait reported its highest ever level of revenue and profit.  Sales were up, earnings per share were up, and margins were only fractionally impacted by the renegotiation agreement with A2 Milk.

The share price plunged 10% in minutes.  It had missed expectations.  In other words, the share price had risen to a point that was no longer justified with this updated data.  The next day, the share price rebounded somewhat.  It has since increased further, with news of a takeover offer for Australian infant formula producers Bellamy’s, by Chinese dairy manufacturer Mengniu.  Clearly, there is still global interest in well-performing dairy assets.

Long-term investors will likely not care about the swings in Synlait’s price.  They will have recalled very similar behaviour at the half yearly report, which investors felt missed the mark too.  The same thing happened in 2018, with the share price tumbling after both the half-year and full-year reports.

Perhaps the market is poor at judging its value.  Perhaps Synlait struggles to accurately convey its forecasts.  Regardless, Synlait has been a relative underperformer this year, as markets chase yield, while growth stocks lag behind.  The fundamentals remain solid.  Concerns around its Pokeno development and Chinese regulatory approvals both seem like short-term issues, provided they conclude as expected.  Both of these issues should see updates shortly.

For Z Energy, an earnings update and small reduction in dividend forecast saw the share price drop more than 15%.

Z Energy now forecasts a dividend in the range of 48 to 50 cents per share.  Previously, it expected the range to be 48 to 54 cents.  The change is hardly likely to cause sleepless nights among shareholders.  The previous year’s dividend was 43 cents, and even at the bottom end of the forecasted range it represents a healthy increase in dividends.

However, conditions have become more difficult.  Z Energy acknowledges that at both the refining end – where it owns 15% of New Zealand Refining – and at the retail side, it is experiencing a squeeze on earnings.

Refining margins fell in early 201, but have recovered.  Competition among the retail fuel sector is firing up.  Investors may have seen headlines in August where competitors of Z Energy were literally giving away petrol for free at stations in Christchurch and Auckland.  Z Energy did not choose to compete with this.  While interest rates may be negative in some parts of the globe, it seems improbable that we will begin witnessing negative fuel prices!

Some may view this dip in the Z Energy share price as evidence of tightening competition, as the likes of BP renews its focus on the retail fuel market.  Others might see it as a buying opportunity during a time of temporary volatility.

Subsequent developments in the Middle East over the past week have shown that although the market is not always predictable, the demand for petrol will continue to be so for the foreseeable future.

_ _ _ _ _ _ _ _ _ _

Goodman Property Trust (GMT) has announced its intention to raise up to $175 million at a fixed price of $2.10.  Up to $25 million of this may be raised from the retail shareholders.

The price represents a reasonably small discount to the current price, and the proceeds will be used to repay debt and fund its development pipeline. 

Retail holders can apply for up to $50,000 worth of shares.  The retail pool size has been set at $15 million, with the ability to accept up to $10 million in oversubscriptions.  Investors will have almost a month to apply, giving them plenty of time to consider their options.  The institutional part of the offer – of $150 million – will be allotted a month earlier (24 September).

The retail offer will likely be pro-rata, meaning investors should not feel compelled to respond immediately.  The size of the discount offered will fluctuate over the period between the offer opening (26 September) and closing (18 October), especially if the institutional investors choose to arbitrage the difference in value during that period.

Whether the size of the retail pool is sufficient remains to be seen.  The large proportion of institutional shareholders may help balance the scales.  If a discount continues to exist at the time of application, investors would be wise to carefully consider the offer.

_ _ _ _ _ _ _ _ _ _

TRAVEL

Edward will be in Taupo on 24 September, in Wellington on Thursday 10 October and in Auckland (Remuera) on Wednesday 16 October.

Chris will be in Christchurch on Tuesday 15 October and Wednesday 16 October.

Kevin will be in Christchurch on 17 October.

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Taking Stock 12 September 2019

When Jenny Shipley more than twenty years ago planned a successful coup to oust Jim Bolger and become our first (but unelected) female Prime Minister she showed great political cunning and experience.

Her triumph was short-lived, her reign ended by an even smarter political strategist, Helen Clark, leading to Shipley’s retirement and then a misguided, and in my view, doomed pursuit of a career in corporate governance. She had no corporate instincts.

Those with political smarts can be defeated without any personal financial accountability for their public office performance, except at the voting booths.

Corporate governance is a much riskier career choice, skills, knowledge and experience being essential and personal financial liability being the outcome of those who fail.

Many politicians drift into corporate governance, based on their media profile, which somehow converts into shareholder votes, especially when Asian shareholders control the vote.

Asian awareness of the power of their politicians often results in misplaced respect for political leaders, even in those parts of the world where the local commercial sector collectively has little respect for political careers. Only rarely do we observe former politicians reverting to a successful life in the world of commerce. I cannot think of any recent examples.

Former politicians whose inexperience tempts them to hurtle into the hurly-burly world of commerce sometimes believe that they can cover off their liability by insuring against the errors for which they may be held accountable.

All of the above is a long introduction to the topic of Directors and Officers Insurance, a subject I regard as a major impediment to the pursuit of high governance standards, and of investor protection.

This may seem counter-intuitive, given that in theory the availability of insurance might be the key factor that persuades relevant and competent people to take on a task with so much personal accountability. In theory insurance should be a factor in the decision to govern, or not to govern.

My observation is that the insurance, referred to in corporate rooms as D&O, has become a product that encourages mediocrity and poor process. In effect D&O results in shareholders themselves double paying for poor performance by paying to insure mediocrity.

The shareholders, invariably without any consultation, are paying the immense and rising cost of the insurance policy, with no explanation or detail of the policies bought.

When a claim is lodged the insurer then defends aggressively to the disadvantage of the plaintiffs, often the shareholders, taking charge of the strategy to minimise cost. In these cases the defendants have a deep-pocketed legal team. Often the plaintiffs, the shareholders, have no such support.

What is worse is that the errant directors are now able to arrange for shareholders to buy D&O cover that eliminates any director liability for negligence or incompetence.

The company and its shareholders are paying even higher premiums, to eliminate the excess for the directors.

In effect shareholder money is being used to cover up mediocrity while insurers, naturally wanting to minimise compensation, are using their immense resources to first delay and then minimise any pay-out required to offset governance failures.

The subject is about to be closely scrutinised by our highest courts.

Shipley herself will be a central figure in an ongoing legal debate. It will be preoccupying her.

Unwisely in my view she took on the role of chairman of the NZX-listed construction company, Mainzeal, which was controlled by a Chinese investor Richard Yan.

Of all Asian countries the Chinese have the highest regard for politicians, failing to appreciate that the power and omniscience of China’s politicians is not replicated in western democracies.

Shipley, with no more experience in construction than she has in fire-eating or investment banking, became Yan’s chairman. Mainzeal insured her and the other directors for a maximum liability of six million dollars, and paid the extra premium so that there was no excess on the insurance, for her, personally.

In other words, insurance covered the total liability for errors, negligence or incompetent process, up to six million dollars, per director. Six million dollars far exceeds most awards for individual director failures.

Mainzeal collapsed, dreadfully governed.

The court found Shipley and two of her directors, plus Yan, were liable for the shareholder losses that exceeded $100 million.

The court has the right to discount the directors’ liability, taking into account any offsetting matters.

For example a director who sought to oppose bad decisions, or remedy errors, or perhaps had some other merit, might find that the judge discounted personal liability. (I presume the errant directors do not receive discounts for being good footy players.)

In the case of Mainzeal, Shipley and two of the other directors had their liability discounted to exactly six million dollars each, somewhat miraculously the precise figure covered by the insurers. (Miracles do happen, it seems).

One imagines she and the other two directors were immensely relieved. Yan was fingered for $18 million, himself.

However the insurer, whose money would pay the awards, calls all the shots, sets the strategy for the court case, and has no requirement to take into account the opinions of the directors for whom the insurer acts.

Shipley and the other directors, one imagines, would have been mortified when the insurer announced it would appeal the judge’s award, opening the way for the plaintiffs (the shareholders) to counter-appeal, the plaintiffs seeking a much lower discount from the full sum, effectively arguing for awards much greater than six million against Shipley and the other directors already found to be accountable for the loss.

The counter-appeal exposes Shipley and the other directors to the possibility of an uncomfortable level of personal accountability, payable by themselves, no further insurance cover being available.

The Court of Appeal will hear the appeal but nothing is more certain than a subsequent appeal to the Supreme Court by whichever parties do not like the Court of Appeal’s opinion.

This whole case displays all of the aspects of D&O that in my view need review:

1. Shareholders paying higher premiums to cover personal excess on policies. Personal liability should never be nil.

2. Insurance companies using their power to bully the other parties (who effectively pay the premiums!).

3. Extreme cost and delays in achieving justice.

4. Obstacles placed in front of a just and timely outcome, by self-focussed insurers.

5. Poor disclosure of the policies, paid for by shareholders. Surely the details of the policy should be displayed.

I know few people who admire the behaviour of insurance companies. Those institutions use smart-alec ‘’legal’’ strategies to obstruct justice, far too often, as we have seen most obviously after the Christchurch earthquakes.

The CBL fiasco displayed how poorly insurance companies are governed, and how badly the companies lack transparency.

The relevance of D&O is high.

The relatively recent encouragement to use litigation funders to tackle the poorest directors and the ugly insurance industry has levelled the playing field.

However in my view much better law, better practices, better transparency, and appropriate personal penalties for incompetence are all steps that should be taken before having to rely on litigation funders to perform ‘’God’s work’’.

I want to see regulators prosecuting poor performers and personal penalties being applied to restore a focus on attracting appropriate directors with the energy and skills to achieve results.

Hopefully the NZ Shareholders Association and the Institute of Directors will provide the impetus to achieve change.

Poor performers, who cause or oversee unnecessary losses for shareholders, should be recognised formally as unfit or improper and should be banned from participation in financial markets, where other people’s money deserves the best governance standards.

Once we have addressed D&O and built a proper and transparent matrix by which we assess fit and proper people we should see a return of confidence in new governors and their real value and importance.

Right now, our standards are laughably low. Muppets abound.

 _ _ _ _ _ _ _ _ _ _ _ _

The task force commissioned by the NZX to consider the future has reported back with some sensible thoughts on how KiwiSaver can be improved, and how its funds can help build New Zealand’s real wealth.

One hopes that some time soon the NZX will also consider issues like:-

- The performance of directors and the definition of independent directors.

- The need to improve the audit function (compulsory rotation)

- The rights of shareholders to oversee executive remuneration, corporate sponsorship budgets and Directors and Officers insurance.

- The publishing of a matrix that guides the regulators who judge the key questions of who are fit and proper people for governance and executive roles.

Perhaps it is the FMA that must move to rein in insolvency practitioners, currently omnipotent but too often listening to just one voice, the party who has the cheque book to pay (overpay) them.

Perhaps it is the legislators who need to climb above mediocrity and define binary outcomes for negligence and incompetence.

I accept that NZ has a small talent pool, but it is hard to accept that outcomes such as we saw with CBL Insurance, and, of course, South Canterbury Finance, where there were no repercussions for the large number of parties whose performance in these debacles was abysmal.

The buzzword for the next decade should be accountability.

 _ _ _ _ _ _ _ _ _ _ _ _

David Colman writes:

A recent Standard & Poors Global Equity Indices monthly update caught my eye as it showed that the cumulative total returns over the past five years were higher in New Zealand than in any of the developed countries.

Total returns in the New Zealand share market were an extraordinary 64% over the past five years (to the end of August this year) - ahead of the USA (+57%), the Netherlands (+52%) and Denmark (+35%).

New Zealand was outperformed only by one emerging market country (Hungary, a remarkable 93%) with no other emerging nation even close. Stocks on the Budapest Stock Exchange headed Russia (+39%) which was second of the emerging economies.

New Zealand investors are experiencing an extraordinary sharemarket joyride in a buoyant economy characterised by low sovereign debt, population growth, stronger tourism figures and growing commodity prices.

The S&P update also presents currency performance showing the New Zealand dollar has dropped, like most global currencies, measured against the US dollar.

Cumulative currency returns in New Zealand are down 24% in the past five years against the greenback.

Only the Israeli shekel, of the developed countries, and the Thai baht, of the emerging economies, have gained slightly against the US dollar over that period.

Despite the depreciation of the kiwi dollar we would find perhaps only a dozen countries noticeably more expensive to visit, or to purchase goods from, than five years ago.

Sadly, for All Blacks fans travelling to the 2019 Rugby World Cup, the Japanese yen has become considerably more expensive (100 yen will cost NZ$1.50, 30c more than when the All Blacks retained the Webb Ellis Trophy at the last World Cup).

The New Zealand dollar is at a more favourable level for New Zealand exporters of late and the majority of annual reports released in August were robust, although executives continue to describe headwinds such as higher risks associated with human capital, global economic issues and increasing references to costs associated with human impacts on the environment.

New Zealand business confidence continues to be subdued against the tide of further share price rises. This seems unusual, if not downright bizarre.

Interest rates continue to slide. The Reserve Bank Governor Adrian Orr is practically yelling at New Zealanders to spend money in pursuit of restoring inflation to 2%.

I do not think the Governor's pleas fall on deaf ears. I suspect an established pattern is preventing the desired level of spending. The small number of people with the most disposable income are savers, not spenders, and the large number of people with the least income have none to dispose of after rent or mortgage payments, and a mound of other ongoing expenses.

A record low Official Cash Rate of 1.00% seems likely to remain or be reduced further before the end of the year and is unlikely to change the above paradigm.

Across the Tasman, the Reserve Bank of Australia kept the Australian cash rate at 1.00% last week and comments were similar to recent comments from the RBNZ regarding the need to keep interest rates low for some time.

A bright spot in the RBA announcement was that property market conditions had improved, particularly in Sydney and Melbourne, which is welcome news to Auckland property owners who may have feared recent poor Australian property market conditions could jump the ditch.

Interest rate cuts and tax cuts for lower to middle income earners were given as reasons for the improvement in the Australian property market.

Tax cuts may have been noted by the New Zealand Coalition Government as a potential carrot come election time. If the downbeat business outlook becomes a reality or if there continues to be whispers of a possible recession, I am sure such a carrot, whether it is actually warranted or not, would be appetising to many voters and may alleviate a little pressure on the Reserve Bank as well.

Recent New Zealand sharemarket performance seems to indicate that gloomy predictions are being ignored.

At the start of the year the New Zealand 50 Gross Index was just above 8,700 points.

Last week marked the first time the NZ50G Index finally reached and surpassed an 11,000 point milestone.

Investors in New Zealand shares in the past five years and longer should be celebrating the success of many of our listed companies and continuing to review their portfolios regularly and carefully.

Extraordinary sharemarket gains can offer investors room to explore investment options using profits from shares that have risen greatly in value to buy shares in companies representing industries and sectors that may not be present in their portfolio.

Further diversity may also be found in other asset types which, without recent gains, may not have been considered before, such as allocating some funds to precious metals, or other alternative investments for diversification. However the subject should be approached with caution, and after discussion with knowledgeable advisers.

It would be great to see more new issues to offer investors further opportunities as it is hard not to see that the small scale of the New Zealand sharemarket is becoming insufficient to absorb the force of funds flowing from expiring fixed interest investments, KiwiSaver funds, ETFs, other fund managers, and proceeds from realised capital gains.

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Travel

Edward Lee will be in Napier on 16 September, in Taupo, 24 September and Wellington on 10 October.

David Colman will be in New Plymouth on 19 September.

Kevin Gloag will be in Christchurch on 17 October.

Chris Lee

Managing Director

Chris Lee & Partners Limited

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Taking Stock 5 September 2019

 

Chris Lee writes:

The admirable ambition of Reserve Bank governor Adrian Orr to de-risk our major banks is gradually leading to significant changes in our capital markets.

Orr quite correctly wants to avoid a repeat of the 2008-2010 era when our major banks and finance companies had to be underwritten by taxpayers to avoid a crisis.

Governments are hopeless at managing such a liability, in 2010 leaving NZ with an unnecessary cost of at least a billion dollars, largely thanks to the incompetence of John Key’s government, as described in the book The Billion Dollar Bonfire.

Orr has private sector experience and capital market experience, and is far from incompetent.

He would know that in 2008 the BNZ was rescued by its Australian parent, National Australia Bank. This was not the first time the BNZ has been rescued.

Knowledgeable business journalists will recall those tensions.

Unknowledgeable radio jocks writing newspaper opinion pieces clearly should restrict themselves to comment on areas where they have knowledge. Last week a radio talkback fellow wrote in the NZ Herald that it was ridiculous for Orr to focus on bank stability. No need, the jock spouted. Wise people do not display their ignorance.

Orr knows that stress in markets leads to unexpected consequences.

Orr’s timely intervention has led to banking grumpiness.

He demands banks increase their capital and that they review their culture, and do something to improve it.

Banks to date have responded in public by threatening to call in dairy loans, to reduce their lending generally, and to convert the cost of the new requirement into higher lending margins. They prefer to focus on return on capital today, rather than long-term profitability and sustainability. Their bonus system encourages such American-like stupidity.

Yet away from the sight of irrelevant commentators, banks have made changes, preparing to exit those activities that require more capital, slicing off marginal branches and other areas that are easy to sell (like UDC, private wealth businesses, and sharebroking divisions).

At the public level the banks have unwisely sought to use public relations strategies to win over the media, the ANZ using media smoocher Key, though this time the media is searching for evidence of substance, somewhat negating Key’s value in the ANZ campaign.

Certainly the ANZ, to date, has behaved amateurishly in not offering substance. Key may well have lost his value to the ANZ.

That the banks are withdrawing from risk areas does not mean that there will be an end to the high-margin activities like property development funding.

The banks’ withdrawal will mean a rebirth of non-bank lending companies.

In Auckland a property lending team comprising experienced lenders, Pearlfisher, two years ago combined with Jardens to arrange money from wealthy individuals to fuel the activity.

There has been evidence that the street knowledge of these people somewhat constrains the behaviour of the sort of cowboys who caused the demise of companies like Strategic Finance a decade ago. Pearlfisher and Jarden clearly know how to reduce and price risk.

Now we read the real estate company, Bayleys, is combining with Dunedin sharebrokers Forsyth Barr, and an Australian broking firm MaxCap Group, to fund property developments, hoping to fill a market abandoned by the banks.

Bayleys should have some useful networks, if no obvious expertise in moneylending, while Forsyth Barr ought to have a useful network of wealthy Otago investors to provide funds. Presumably MaxCap has moneylending and documentation skills.

It seems this new moneylending company will sidestep the retail funding market, understandably not impressed by the much stricter requirements of any finance company wanting to interact with retail investors.

The activity seems to be a clever target for Forsyth Barr, which, in a year’s time, is likely to look very different from the retail broking firm nurtured by Eion Edgar, his younger, modern sons now energising the business, directly or indirectly.

We will all continue to await the arrival of a new modern finance company, seeking public subscriptions. Investors would welcome such a company if it were structured and regulated competently.

Currently there is no retail finance company structured in a way that would lead to returns for risk that would tempt me. None.

UDC’s closure has removed from our shelves the only company I would use.

That will change as banks restructure. New finance companies are inevitable.

My guess is that as banks shrink, there will be fair returns for risk in many lending sectors. The key to their acceptance will be fit and proper people in governance and executive roles, a modern, regulator-approved trust deed, a new breed of competence in trust deed supervision, and a degree of transparency in reporting not seen in the last finance company cycle.

I am encouraged by the attitude of the regulators, (the Reserve Bank and the Financial Markets Authority).

I am less encouraged by the view of the legislators, who seem to believe the current laws cover all bases.

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Few would query that the king of retirement villages in New Zealand is John Ryder, the co-founder of Rymans and now part owner of New Zealand’s most stylish modern village, Alpine View, near Marshland in Christchurch.

Ryman is unarguably the market leader. Ryder retired from Ryman 12 years ago.

Many years later, after he had met the terms of his promise not to compete with Ryman, Ryder helped the O’Dowd family to complete Alpine View. It is a fabulous, market-leading village.

After decades of involvement with New Zealand’s most beautiful retirement village, Parkwood, in Waikanae, I visited Alpine View and marvelled at its range of designs, its outstanding facilities, including theatres, a bar and a modern restaurant. Its design was world class.

For the past two years Ryder has been acquiring land to build a series of top-of-the-range villages, leading to a hope that he would create a new public-listed company, this time offering the public shares in a chain of blue ribbon villages.

Sadly the opportunity I relished was spotted by Ross George and his clever people at Direct Capital in Auckland, a private equity company.

Direct Capital may well have nibbled a lemon or two in the past – Perpetual Guardian being one, in my view – but he made an easy shilling or two when he took Scales Corp off the hapless receiver of South Canterbury Finance and he may do really well from joining up as a source of money with Ryder’s new group.

Direct Capital will fund Ryder’s group so the retirement village operator will not need public subscription, at least in its development stage.

I expect one day Direct Capital and Ryder will list it on the stock exchange but they may wait until the risks and returns are lower.

Ryder’s contribution to New Zealand’s retirement village sector has been immense.

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I will be reporting progress (if any) on the urgent need to improve the laws that control financial markets.

A most obvious and urgent need is with insolvency practitioners, that is receivers, liquidators and statutory managers.

Throughout my career, and especially in recent years, these people have in general been uncontrolled, able to claim extreme reward, without visible value-add.

The unsecured creditors and shareholders have regularly been sacrificed at the altar of banks.

Their willingness to maximise returns by testing the accountability of auditors, directors, trustees and bankers has been feeble, implying that they serve obsequiously the corporate world that engages with them.

Obviously there have been occasional exceptions but if the anecdotes I field are even half true there is an urgent need to force insolvency practitioners to be answerable to an independent panel which includes unsecured creditors, investors and shareholders.

The insolvency practitioners self-regulate!

This must change. The FMA is the correct body to regulate the practitioners.

There must be easy access to the courts – low cost and rapid to hear complaints that the insolvency practitioners have not made every effort to maximise recoveries.

If any readers of Taking Stock have relevant evidence of incompetence or inertia, please email me (chris@chrislee.co.nz) with relevant failures.

The status quo must be overturned.

I will be making submissions to sharpen the Insolvency Practitioners Act.

(Anyone wanting confirmation of my assertions should read The Billion Dollar Bonfire. The book is still available in most book shops.)

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Johnny Lee writes:

The New Zealand economy continues its bumpy ride, with mixed signals from various indicators making it difficult to diagnose the general health of the economic environment.

Such a ‘doctor’ might look at a few specific areas when making a diagnosis. This would include unemployment, confidence and growth.

Both unemployment and employment continue to trend at extremely healthy levels. Unemployment is at historic lows, especially among men. Many businesses are reporting difficulty hiring staff, especially in industries which have typically been male-dominated. Employment has also been high, although it has fallen from its peak, as participation dipped slightly.

Confidence surveys are producing a slightly different verdict. Consumer confidence – which is the outlook consumers have over the medium term, remains strong. Generally speaking, consumers are expecting both house prices and consumer prices to go up, and that the economy will make them better off over the next 12 months.

Business confidence, however, remains weak, and has been generally declining for about two years. Most of the firms surveyed intend to reduce employment, seeing higher costs and reduced profitability. Some of this is logical – for example, the retail sector sees the rapidly rising minimum wage as being a major driver of cost pressure.

Sectors including agriculture, construction and manufacturing are particularly pessimistic. This would not be news to most investors, who have seen listed companies in these areas (such as Fonterra and Fletcher Building) struggle this year, while most other listed companies are enjoying profit growth and strong share price performance.

Manufacturing had been slowly expanding, but the most recent survey saw the sector contracting for the first time in seven years. Time will reveal whether this indicates a trend, or a blip.

Inflation data provides a ‘lagging’ view, in that it confirms information that is broadly already predicted using other indicators. Inflation in New Zealand has had a slow 2019, tracking below the Reserve Bank’s 2% medium term target. Inflation is also being supported by specific inputs – such as tobacco products, meat, insurance and council rates.

All four of those drivers are likely to continue to see upward pressure. Very few councils are writing letters to their constituents advising of falling rates. Most seem to be campaigning on new spending initiatives. Meanwhile, insurers are actively withdrawing from markets, rather than trying to compete for business.

Summarising these symptoms does not produce a clear diagnosis. Consumers are largely happy to spend, and expect conditions to improve. They expect prices to increase, which encourages spending now. They expect house prices to increase, which again incentivises bringing forward expenditure.

Businesses, especially in the rural and construction sectors, are overwhelmingly pessimistic and have been for years. Employment intentions are down, and costs are rising. Margins in some industries are being squeezed by international pressures. Some Governments are responding to this pressure with artificial barriers (tariffs). New Zealand does not have much leverage in this regard, and will generally be at the mercy of market forces.

Costs are rising, but in specific pockets that are largely out of the control of consumers. One cannot simply refuse to pay one’s rates. Few choose to simply remain totally uninsured except by necessity. Other expenses are cut instead.

For an investor, the data supports investing in strong, profitable companies, selling goods or services that are not subject to international pressures - especially in companies that have monopolies or duopolies. Those that are borrowing at low (and falling) interest rates will see added benefits from the economic environment, as will those selling products essential to society.

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Travel

Edward will be in Wellington on 12 September, in Napier on 16 September and Taupo on 24 September.

David will be in Lower Hutt on Wednesday 11 September and in New Plymouth on Thursday 19 September.

Chris Lee            

Johnny Lee

 

Chris Lee & Partners Ltd

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