Taking Stock 30 September 2021

THE number of people who live in retirement villages in New Zealand is still fewer than 50,000.

In 10 years' time that figure will be closer to 100,000.

What this means is that more than 80 percent of people of ''senior'' age do not live in such villages. But demand is growing. I look to the past to see how this sector has coped with rapid growth.

When Parklands retirement village was initiated by a community trust in Waikanae in 1971, New Zealand had no retirement facilities that even faintly resembled the modern villages that exist today.

Parklands soon after 1971 developed Woodlands on an adjacent site and today it is Parkwood Retirement Village, housing around 300 people, including those in its private hospital wing, on a site of some 40 acres, much of it used for gardens and lakes. It appeals to people who love fauna, flora, lakes, birdlife, and open spaces.

It surveys its residents each year, inviting anonymous feedback. I will refer back to this later in the article.

Before applying to buy a dwelling in the village its residents must receive independent legal advice. They pay key money to enter the village and receive around 80-90% of the sale price (not the entry price) upon their exit. In almost 100% of cases ''exit'' is a euphemism for death. Other villages charge no key money but do not share capital gain.

Parkwood residents pay a changing, monthly fee towards the village's ongoing costs – staffing, roading, utilities etc – which over the years has risen to around $6,000 per year. Parkwood has no borrowings and retains a seven-figure bank deposit. It pays no dividends and stores profit to maintain its standards indefinitely. It has around 140 staff.

Its community facilities are rather wider than many other villages. They include a cost-free care team, who help those living independently when they are unwell or have a special need, and an events team, which arranges attendance at events, domestic travel and, until Covid, international group travel. A paid staff member accompanies residents on such outings, to attend to mundane tasks.

Parkwood has a range of recreational facilities (bowls, swimming, gym, table tennis.) It also has a full library well managed by residents and many resident-managed hobby groups embracing arts, crafts, bridge etc.

Its board of directors is selected by its existing board, guided by the founding sponsors and a constitution.

The board includes two residents nominated by the Residents' Association. The board appoints the chairman.

Its dwellings are generally priced at around 70% of the value of Waikanae's external property prices, a modern large bespoke villa these days costing more than $500,000.

Residents who entered the village 20 years ago would have paid for the same villa rather less than $300,000 and would be sharing the capital gain.

Parkwood is an example of a spacious, well-designed, low-density village, with management and staff that have for decades been outstanding; caring, competent, and kind.

As a result, Parkwood often has had a list of people who want to work there when a vacancy occurs, and it has a long list, of far more than 100 people, who await the call to move into the village.

Its founder, Lloyd Parker, and his guiding financial mentor, Ray Spackman, created New Zealand's first foray into a retirement village, and would be smiling from their positions in the clouds. They set a standard that a whole industry follows.

Now to revert back to the annual survey: the outcome of all this kind, client-first focus, is that very close to 100% of residents, for each of the past 20 years, report the highest possible level of satisfaction with the village, with the survey measuring all aspects of Parkwood, including value for money.

I am reasonably certain of my facts as for nearly three decades I was first deputy chairman, then for more than 20 years, chairman of its board, my task made simple by the appointment of an outstanding chief executive in 1994 (Mark Rouse), whose retirement is now taking place.

I record all of this because Parkwood Retirement Village has led to the development of my knowledge of a sector that throughout New Zealand has greatly enhanced the retirement lives of hundreds of thousands of New Zealanders, over those decades.

I have visited villages of many of Parkwood's competitors, I have often been invited to meet with, or address, management and residents of other villages, and my business no doubt has a fair number of clients who live in retirement villages. I am comfortable that I am well informed.

Parkwood may not be ''the best'' retirement village. Most villages are just wonderful, in my opinion. But it is an excellent village.

Yes, I am aware of rare residents who have not always been happy, even the odd one who would be described as a malcontent, or a discontent.

One resident years ago was moved to fury because of the noise of the birdlife in the abundant foliage at Parkwood. Another intensely disliked the roundabouts created to ensure slow traffic speed.

Here is my point. I am certain that the national percentage of unhappy retirement village residents is much lower than the number of women who do not want men officiating or reporting on women's sport, least of all televised women's sport. Maybe men might feel the same about men's sport.

That number can be acknowledged, even respected, but it should not cause the Ardern government to instruct the Minister of Sport to consult with his ministry and seek to bring in law change to satisfy these complainants. These matters can be resolved as public opinion evolves.

The Commissioner for Seniors is Jane Wrightson who, like all public sector heads, engages with her minister and, increasingly, seems to be guided by a political agenda, a situation which may have worrying implications for those who do not like American-like politicisation of the public service.

Retirement villages, or at least the major firms (Ryman, Summerset, Bupa, Oceania, Metlife) are big businesses, employing many thousands of people, and catering collectively for probably 35,000 senior citizens. They do a great job, despite perpetual problems, often caused by government interference.

Ardern's government, not unnaturally, is not business-focused and could not be, its caucus comprising barely a single person to have entered politics after a career in business successfully executing business-like strategies. There may be none with that background.

My fear is that Wrightson, and many other such appointments, might be over-extending their brief by focusing on the tiny percentage of malcontents and discontents who have moved into retirement villages and now find the terms of living there to be unsatisfactory.

Yes, there will be examples of poor behaviour in villages, quite easily identified. Just Googling the small operators will find historical cases of poor standards and poor care.

Those villages might deserve attention, but any thought of new industry-wide radical change might be as unhelpful as some new edict that bans men from wanting to officiate or commentate on women's sport.

If Wrightson feels she has to extrapolate the handling of odd complaints into a full-blown mission, she should first survey all residents, and discover whether any imperfections can be handled adequately by the interaction between residents, their families and the village owners.

It is greatly insulting to residents to suggest that they entered villages by being duped, sucked into a system they did not understand. By and large, residents probably receive more than they expected from village life.

The retirement village model in New Zealand is user-friendly, world-leading in that its facilities are generally excellent, its standards of care are admirable, and its cost effectiveness is high.

One should tread very gently on unbroken eggs.

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THOSE who have demonstrated faith in Pacific Edge's ambition to detect bladder cancer without invasive or expensive inspection will any day be invited to invest more at a discounted share price.

Pacific Edge (PEB) has just raised an astonishing NZ$80 million from institutions and those private investors who individually had put more than $500,000 into just one ambitious, still unproven, company that was aspiring to gain scale in the health sector.

These wholesale investors last week agreed to buy around 60 million new shares at A$1.31 (NZ$1.35), surprising PEB and its organising brokers, who had expected to revert to retail investors in their quest for new money.

PEB's share price, after the institutional placement at NZ$1.35, has risen above $1.50.

It will now raise another $20 million by offering new shares to existing shareholders at the same price as the deep-pocketed investors, and has the right to accept over-subscriptions.

Smaller shareholders will buy confidently, now knowing that the new institutional money underwrites several years of the funding needed to convert PEB from a cash burn company to a profitable company, buying PEB the time to convert the recent international approval of its product into cash sales, leading to profits and, possibly, dividends.

The placement to existing shareholders will be seen as a no-brainer, provided the fixed price remains around 12% lower than the market price.

PEB, meanwhile, faces a few questions from the NZX's regulator (NZR) which will want to know why the placement was announced prematurely in Australia, perhaps enabling Australians to buy immediately into PEB, with the motive of gaining access to the discounted retail or wholesale placement.

Symmetry of information is important and worthy of regulator attention.

Fat thumbs is a credible defence, in this case implying a simple error, perhaps caused by sloppy communication, leading to a premature announcement in Australia.

I would be fairly certain the error was not designed to create a cheap entry point for Australian investors.

Yet errors need fixing.

A possible solution would be to offer discounted shares to all those who had sold to the Australians as a result of the error. It would be virtually impossible to reverse the sales as a means of remedy.

If PEB can accept over-subscriptions, it would not be inconvenienced by such a remedy.

My expectation is that fixing the problem might involve the issue of a few million more shares at the discounted price.

PEB remains a company with an interesting product in the health sector, yet its adoption by world health markets remains slower than PEB has anticipated.

If it succeeds this year in converting medical acceptance into dollars, PEB might be able to reward those who for many years have endured the exaggerated optimism of it board, whose anticipation of sales success has been premature, by any fair judgement.

As a tiny shareholder, I would be delighted but I shall continue to exhale, not holding my breath at the risk of a financial expiration!

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Johnny Lee writes:

Kiwisaver's annual report has been published, providing an insight into the collective investment strategy of the 3.1 million New Zealanders using our national saving scheme.

Any analysis extracted from the report must be prefaced by a reminder that the timing of the report makes the data unintentionally misleading. The report covers the year ending 31 March 2021, which means it begins shortly after the collapse in share prices following the first outbreak of COVID. March 2020 ended with our sharemarket index below 10,000 points. It has since recovered to over 13,000, where it has hovered for most of the 2021 calendar year.

This means that the $13.2 billion in investment returns must be considered against a backdrop of the $821 million dollar decline from investment returns the year prior. It was inevitable that the overall performance was going to see a recovery, but the Financial Markets Authority (and Kiwisaver investors!) will nevertheless be pleased to see such strong figures come through.

The report also provided evidence for the anecdotal reports of panic-induced fund switching which occurred during COVID.

For years, investors have been progressively shifting out of conservative and cash funds towards balanced and growth. Cash and conservative funds once made up a third of Kiwisaver money – today, it is less than a fifth.

March 2020, however, saw a dramatic shift in investor behaviour. Close to 35,000 Kiwisaver members moved out of growth and balanced funds back in favour of conservative and cash funds, a movement that has yet to fully reverse.

Part of this shift was undoubtedly driven by the overwhelming coverage by the press, both in regard to the sudden fall in Kiwisaver balances, and the alarming death rates observed after the initial wave of COVID. After the market recovered, the FMA took it upon itself to commission PwC to conduct interviews with these people to better understand the rationale for changes.

The FMA’s decision to conduct these case studies was a good one. Although the survey was not broad enough to be described as scientific, it did confirm that many chose to make these decisions based on financial advice received from pundits on social media, including Instagram and Facebook. All expressed regret at their decision (for obvious reasons, in retrospect) and conveyed a disappointment in what they saw as a failure on the part of the fund managers to adequately inform their investors to ensure they made good decisions. It is an intoxicating thought that fund managers foresaw the outcome of the COVID outbreak.

Fees were also discussed by the FMA. As expected, fee income from the fund managers grew substantially, being based off the value of assets under management. Administration fees have largely been erased. The FMA hopes that as funds continue to grow in scale, the management fees charged can decline without impacting the managers' ability to recruit skilled staff and have appropriate levels of oversight. It can be taken as a certainty that performance or bonus fees will not be a long-term feature of Kiwisaver funds management.

The 2021 year continued the trend of very strong growth in ''Socially Responsible'' investment – by far the fastest growing investment strategy both here and abroad.

This trend towards ''ethical investing'' should be considered carefully by all members of the investment community. Fund managers are already increasingly incorporating these ''ethical'' principles into their investing philosophies, seeking to capture a pool of funds that is likely only to grow from this point. Regardless of your stance on the importance of ''ethics'' when considering an investment, investors now know that for companies to have access to the deepest (and cheapest) pools of liquidity, they would need to cater to this community.

The only group of funds to actually decline in value were the cash funds, in part due to the slow unwinding of the aforementioned changes in investor behaviour, but also due to the relatively poor returns achieved by cash investments over that timeframe. While cash is often regarded as an asset of choice for those anticipating an imminent withdrawal or a sudden reduction in asset prices, its long-term performance should highlight its unsuitability as a significant part of retirement planning.

Overall, Kiwisaver is growing very quickly, both in terms of investment returns and in-flows from contributions. At $78 billion ($57 billion last year), it has become a very significant part of our capital markets. As it continues to grow, it will increasingly encounter liquidity problems, as options for investment dry up. We have already heard of Kiwisaver funds putting money into mortgages and venture capital funds, and expect these trends towards alternative investments to continue.

If 15% of Kiwisaver money ($12 billion) is directed to the New Zealand sharemarket, the significance of this can be seen by comparing it to the total value of the NZX of $180 billion.

The trends observed in these annual reports give us all a glimpse into how our markets are evolving.

These trends include a willingness to take greater risk and rising emphasis on the ethics of the companies people will consider investing in – something companies and investors will need to remain mindful of as Kiwisaver continues to grow.

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Edward will be in Napier on 7 October & 8 October, Blenheim on 13 October, Nelson on 14 October and Wellington on 15 October.

Kevin will be in Christchurch on Thursday October 21.

Johnny will be in Tauranga on Thursday October 21.

Chris plans to be in Christchurch on Tuesday October 26 and Wednesday (am) October 27 and plans to be in Auckland on October 19 and 20, at Albany and Ellerslie, if COVID allows.

Any client wishing to arrange a meeting is welcome to contact the office.

Chris Lee

Managing Director

Chris Lee & Partners Limited

Taking Stock 23 September 2021

LAST week the stinking corpse of Bridgecorp was finally incinerated; removed from the Companies Office register, its remains no longer even useful for scavenging hawks.

Its cremation was recorded by Paul McBeth of the Business Desk in an accurate article he sent me at 5.04am last Friday.

Within two hours I had written to him, noting his accurate comments, and providing him with some details that he might have found rounded out his records of all the evil that Bridgecorp and its founder Rod Petricevic had created in that ugly era.

Beating me in my timely reply was a retired fund manager, one of New Zealand's best in his day, who asked McBeth why the receivers, PwC, had returned to investors so little of the money they had retrieved from the Bridgecorp loan portfolio.

Close to a third of all recoveries had been absorbed by the retrieval process, some $36 million of $117 million not being returned to the first-ranking secured debenture holders.

When Bridgecorp finally collapsed in 2007, McBeth was an inexperienced reporter, with no particular knowledge of the finance company sector.

Today he is experienced, careful, and an integral part of the Business Desk news service, available to those who pay their subscriptions to its founder, the savvy and award-winning business journalist, Pattrick Smellie.

McBeth responded to the issue raised, of the disappearing funds, itemising the amounts that were paid out by the receiver.

Of the $117 million retrieved, PwC was forced to pay $3.8 million to preferred creditors, granted their elevated status by Bridgecorp's goofy trustee company, Covenant (now part of Perpetual Guardian), a concession Covenant granted rather than acknowledge that Bridgecorp was a corpse still twitching only because of the electric prodding instrument that its owners were brandishing.

Covenant should have closed Bridgecorp's door years before it did.

Bridgecorp had claimed that all of its loans were insured by Lloyds of London, an AAA- rated insurer.

Its loans were largely secured by second and third mortgages and those that claimed first mortgage status had consumed far more debt money than the asset was worth. There never has been a credible insurer who would underwrite junk loans. Lloyds certainly did not.

Predictably PwC did not identify in its final report any recoveries from the fake insurance claim trumpeted in Bridgecorp's investment statements.

From the $117 million recovered, PwC paid law firms a mere $6.9m for their advice and a further $1.5m in ''other professional costs''.

PwC deducted itself, as a ''receiver's fee'', $5.1m but also deducted ''other operational costs'' of $4.59m.

A mere $7m was deducted for ''direct loan/property expenditure''. Other costs absorbed around $11 million. Frame your own opinion on who were the winners from the receivership.

McBeth's article raised several issues that still need to be addressed.

- What has been done since the Bridgecorp disaster to make trust deeds an efficient and transparent set of promises that actually protect investors?

- How does the trust company sector acquire owners and executives who are focused on the task of protecting investors, rather than maximising their revenues without infringing the inadequate laws that apply to receiverships?

- How do investors ever assess the fairness of an insolvency outcome while the insolvency practitioner is obliged to make no reference to unsecured creditors or shareholders, who rank below the secured creditor, usually a bank or the trustee, which appoints the receiver?

- Why is there not a creditors' committee to oversee every bill payable by the receiver and challenge any bill that seems to be ''padded'' or, worse still, blatantly excessive?

- Why is there no easy, no-cost access to a judicial panel to monitor the behaviour of crooked insolvency practitioners who, for example, gift stock to a family member without recording the transaction, as happened in an unrelated receivership?

- Why are insolvency practitioners authorised to judge who is allowed to practise, and also authorised to regulate the practitioners that have that approval?

McBeth and his Bridgecorp obituary did not directly raise any of these issues but the six questions I pose are still extant, none addressed by an inept and inexperienced Commerce Minister (Faafoi) and an unworldly Ministry of Business, Innovation and Employment.

Within MBIE, the Companies Office sits, stripped of its experience and skill, after the retirements that followed the court-exposed errors that led to the death of South Canterbury Finance.

Just a year or so ago, the Companies Office, because of its inability to attract skilled, experienced staff, was forced to appoint a law firm to take over its primary tasks.

One needs no imagination to calculate the opportunity of revenue that must have meant to law firms, not all of which care if they are seen to be rapacious when calculating their bills.

There simply is no excuse for MBIE's failure to address the weak laws around trust deeds, trustee behaviour, the transparency expected of insolvency practitioners, the need for creditor committees, and the granting of self-regulation to a group of people involved in a business sector where costs far far exceed value-add.

A government heavy on policy-creators, but void of business experience, naïve to an extent that is highly visible, may be better than a government run for the Old Boys Network, hiding greedy behaviour.

But surely New Zealand deserves rules and governance practices that prevent blatant exploitation of investors who have been stripped of their money (and dignity) by crooks.

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NZ Funds Management Ltd (NZFunds) is the privately owned company that recently extracted $51m from its clients as a bonus reward for its private owners and management.

Its revolting bonus was described as a ''performance bonus'' and was legal because its trust deed, filled with all that legalese, allowed such a bonus.

In general, if a fund in one year returned a massive loss, but in later years achieved a return that far exceeded a particular index, or amalgam of indices, then no compensation for the bad year was payable but the windfall recovery had to be diluted by a performance fee.

Generally, such bonuses relate to ''growth'' or ''aggressive'' funds that occasionally may achieve extravagant returns.

The founder of Fisher Funds, Carmel Fisher, who later sold the company to the TSB's community trust, would have a view on this. Her highest risk strategy in the 1980s was to buy very large levels of illiquid, small public companies, often driving up the share price simply by holding a finger on the buy-now button, while she was at Prudential Insurance.

One year she reported a return of nearly 90%. I doubt she was paid any silly bonus.

The next year her fund fell by nearly 90%.

A rise of 90% takes $100 to $190. A subsequent fall takes away 90% of $190, a loss of $171, meaning the $100 has collapsed to be worth just $19.

Obviously, any bonus paid would have been most unjust.

NZFunds achieved its miracle one-year return by trading in what is effectively a non-fungible token – Bitcoin.

Bitcoin is not a currency. Christine Lagarde, previously the Managing Director of the International Monetary Fund, very baldly pronounces Bitcoin to be a token, not a currency.

NZFunds traded these tokens at an opportune time and can be pleased with its opportunism and might even ascribe its success to prescience or, even more improbably, scientific analysis.

Whatever, NZFunds, 35% owned by Russell Tills and Gerald Siddall, has had a $51m gift.

Tills and Siddall have long been opportunists.

It was those people, along with one Douglas Lloyd Somers Edgar, who conceived the wealth-destroying product First Step, marketed by Edgar and Money Managers nearly two decades ago as a fund that offered better returns than bank deposits.

First Step was a bottom-feeding contributory mortgage fund combined with a third-tier finance company loan book, which, amongst other loans, lent tens of millions to Edgar.

The fund was managed incompetently, I would say cynically, and cost investors tens of millions.

To describe it as comparable with bank deposits was pure mischief.

This week NZFunds marketed one of its higher-yielding share-based funds with full page advertisements in what is a normally responsible organ, The Listener. It advertised that an alternative to interest-based funds was its ''4-7%'' fund it manages.

I accept that linguistically speaking, a fund based on receiving dividends, or on sharemarket trading gains, is indeed an ''alternative'' to a boring old fund based on collecting interest from bank deposits or bonds.

A cave filled with rabid Taliban men, as a potential holiday destination for a retired couple, is strictly-speaking, a legitimate ''alternative'' to a holiday at Oneroa on Waiheke Island.

To return from being frivolous, I record that the two choices are not even remotely comparable. The comparison by NZFunds is absurd. So, too, is any forecast on the real returns of a share-based fund.

Likewise, Edgar was right. First Step was an alternative to spending money on a bank deposit as Edgar smooched. Spending money on a firecracker display was another alternative to a bank deposit, he might have said with equal accuracy.

The appearance of NZFunds' unwise advertisement raises one worrying question.

When will our media have enough sustainable income that the different members of the media can stand tall and reject foul-smelling advertisements? For that matter, when will the media end its obsequious affirmation of controversial Government policy, its complicity behaviour perhaps linked to the $50 million the Government doles out to selected media outlets?

Hanover Finance said it was a company that could weather all storms. TV1 ran this balderdash, and took the money.

St Laurence said its owner Kevin Podmore would treat investors' money with the respect he would ascribe to his own mother's money. The media ran with this, and banked his (mother's?) money.

Any other examples?

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Johnny Lee writes:

FALLOUT from the evolving situation in China surrounding property development company Evergrande continues to be felt around the world as traders and investors position themselves in the face of rising uncertainty.

Evergrande is one of the largest Chinese property development companies and owes its lenders about USD$300 billion  – a staggering sum even in the world's most populous country. It has become the country's most indebted company, its share price is crumbling and nervous creditors are trying to apply pressure on the Chinese Government to restore confidence by rescuing investors and effectively underwriting any losses.

The story will be eerily familiar to many readers. Evergrande grew quickly, while borrowing hundreds of billions from investors to fund this expansion. The company grew to include ownership of a soccer team, an electric car manufacturing division, and even investing in New Zealand's dairy sector.

Regulatory changes imposed by the Chinese Government acted, as intended, to be a handbrake to this growth. This forced companies to deleverage – either increasing cash on hand or limiting growth in debt levels.

Evergrande responded by selling assets with very little leverage to achieve pricing tension. The company also asked staff to invest their own money into the company. These loans have reportedly fallen into default, causing staff to stand alongside investors demanding repayment. Lawsuits have emerged.

The stories of ''ghost cities'' in China is well known, entire cities being built with few (if any) residents, constructed to facilitate future growth, funded by small deposits and debt. Theoretically, the apartments, movie theatres, schools, hospitals, badminton courts and supermarkets fill with people over time, as population growth and wealth accumulate. These were long-term projects built on debt, and assumed growth rates, that have since fluctuated wildly.

So far, markets have viewed the Evergrande situation as a ''China problem'' – meaning that global contagion will not be allowed to occur, and any debts will ultimately be paid for by the Chinese Government. Markets are down a few percentage points. Indeed, the prevailing view is that the Chinese Government is simply trying to remind local investors that risks must be considered when investing, before inevitably opening the chequebook to maintain confidence in both the property market and the Government itself.

There may also be a market view that the Chinese Government's solution will not be overt, or even-handed and may never be known.

Economic purists may not like the moral hazard associated with a Government propping up property investors, but this is certainly the assumed conclusion at this point. Other property development groups (and their lenders!) will no doubt be watching the situation unfold. The alternative may be far worse.

The main conclusion we can draw, so far, is to highlight the risks that exist with these types of investments. New Zealand, one would hope, learned these painful lessons in 2008, and in 1987.

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LOCALLY, an impact has already been felt, with Stride Property Group pulling the pin on its proposed plan to demerge its office assets into a separate listed entity.

Barely a week after notifying shareholders of its intentions to create ''Fabric Property Group'' and providing documents for potential investors to mull over, the group has cancelled the plan altogether, citing ''recent market conditions''.

A suddenly-cautious investment environment – particularly in the property space – would justify such a move. The language used in the public statement suggests the cancellation is unlikely to be reversed in the short-term, although the door was left open to revisiting the plan in the future.

The timing is extremely unfortunate. The bulk of the ''work'' in conducting such an endeavour has already occurred. The 103-page Product Disclosure Statement has been created, illustrated, and signed off by the legal department. New roles were created, and investment forecasts updated. Months of analysis led to the announcement. Within a week, it was canned.

For now, investors can disregard all prior correspondence regarding Fabric.

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KIWI Property Group's (KPG.NZX) announcement that it intends to construct an apartment complex for 295 apartments could act as a very intriguing ''proof of concept'' for the industry.

Kiwi Property is best known as the owner of Sylvia Park, originally a shopping complex in Auckland. Sylvia Park has since morphed into an ''integrated retail, office and residential community''.

The latest development of an apartment complex is designed as a ''build-to-rent'' scheme, meaning that Kiwi Property would eventually turn residential landlord, in conjunction with managing its other assets.

The benefits to Kiwi Property are fairly obvious – by securing long-term residents adjacent to the shopping centre, it hopes to also secure long-term customers for the businesses within the shopping centre, increasing those rental values in turn. While online shopping trends are undeniable, this is often driven by an unwillingness to travel. Theoretically, the promise of 1,200 apartments over time, housing perhaps 3,000 people, could pique the interest of potential retailers looking to expand into the area.

This puts Kiwi Property in a unique position to take advantage of a build-to-rent scheme. The returns on such a scheme are not always stellar, but Kiwi Property will see value in other parts of its business.

The advantages for renters are also obvious. Tenants move into a home with a long-term lease, providing stability, in an area with employment, shopping facilities and public transport. Kiwi Property even makes a point to extend an invitation to pets, often a sticking point for long-term tenants.

Execution of the scheme, from design to construction, will be crucial. If Kiwi Property Group can foster a reputation as an excellent provider and manager of residential property, it will find itself faced with enormous demand. New Zealand's demand for housing is notoriously strong, and the idea of living close to both work and entertainment will appeal to many, particularly young people. The location also allows access to and from multiple directions, appealing to vehicle users.

Kiwi Property notes that it has capacity for over a thousand more such apartments over time. Shareholders can afford to be cautiously optimistic that the company has found an interesting opportunity to add value, and if successful, one that could over time be introduced to other sites in the Kiwi Property Group portfolio.

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Kevin will be in Timaru on 30 September (afternoon) and 1 October 2021.

Edward will be in Napier on 7 October & 8 October, Blenheim on 13 October, Nelson on 14 October and Wellington on 15 October.

Johnny will be in Tauranga on 21 October.

Chris plans to be in Christchurch on Tuesday October 26 and Wednesday (am) October 27. Any client wishing to arrange a meeting is welcome to contact the office.

If Covid allows, he intends to be in Auckland in early October and to conduct seminars in November, in North Shore, Auckland, Tauranga, Napier, Palmerston North, Kapiti, Wellington, Nelson, Christchurch and Timaru, and elsewhere if feasible.

Chris Lee

Managing Director

Chris Lee & Partners Limited

Taking Stock 16 September, 2021

FOR about 65% of the population, any discussion on interest rates is about as riveting as new legislation in Germany on the fat content of pet food.

For about 25%, who have mortgages or business debt, the fear is of a chunky rise in the servicing cost of their borrowings.

But for 10%, any significant rise in interest rates is akin to a pay rise.

It is the latter group who will now be cheering, as the various factors that drive interest rates upwards begin to conflate:

- The Reserve Bank is itching to slow the increase of inflation, by raising the overnight cash rate;

- The Australian banks operating here are being bullied by the Reserve Bank into raising hybrid capital (debt dressed up as equity), totalling billions, to shore up bank reserves;

- Corporates are rightly fearful that changes in economic conditions, coinciding with constraints on banks, will lead to the Australian banks restricting their lending, and/or applying more rigid covenants on corporate loans. Logically, the cleverest, most indebted corporates, like Wellington International Airport, will want to raise retail debt to repay the banks, before market conditions react.

Conflate these three changing conditions and the most reasonable expectations will be a genuine rise in bank deposit rates and corporate bond yields, though this will be a view not necessarily accepted, some believing that Delta will lead to a prolonged recession.  However I expect a rate rise, soon.

If I am right, the 10% who manage their own savings would cheer loudest. Those whose savings are in Kiwisaver funds and other managed funds would need to mute their enthusiasm until the fund managers have fessed up to the losses when they mark to market their fixed-interest portfolios.

To convert this last observation to everyday English, the fund managers who have bought long-term, very low-yielding bonds and notes would need to report that these securities are worth much less than they were a few months ago, when yields were at an all-time low.

This would lead to write-downs, and some ugly negative influences on those funds' performances.

Some will argue that these write-downs would be a timely reminder of the dishonest marketing of such funds when they report a final annual return comprising real interest received and TEMPORARY paper gains, caused by the short-term increase in valuations when interest rates are falling.

When gains are reversed, the returns of previous years will be seen as misleading.

Yet eventually all investors in fixed interest will gain when rates rise.

Others will argue that the fund managers made a crass error when they invested other people's money into long-term bonds, at one stage some months ago at rates of around 0.6%. Those investing other people's money were probably reacting to the message that even NZ might succumb to the concept of negative interest rates.  The dopiest of fund managers provided long term mortgage finance at rates that now look silly.

From all of this, the smartest to emerge will be those who accepted pitifully low short-term rates – sometimes literally nothing – while they waited patiently for rates to revert to the 3.0%-4.0% range that we are now seeing.

A year at nil, followed by nine years at 3%, is immensely more rewarding than 10 years at 2%, if you can afford the first year of nil.

Patience is indeed a virtue.

Most who manage their own portfolios use banks for short-term rates (up to two years), as the fee involved in buying bonds for short terms destroys yields.

These investors then look to build a ladder of notes and bonds, gaining better returns and locking in the income on which they rely.

The smarter investors will use bonds that have any of the following features:

- The notes are issued by regulated banks with high capital levels and an established ability to raise equity in tough times;

- The notes are issued by profitable, dominant corporates with credibility gained by a history of success;

- The notes are secured by meaningful, easily-valued, tangible assets.

The securities most feared are those that are subordinated and issued by companies whose real assets are intangible, or by companies still striving to achieve stability.

In recent weeks, Oceania Healthcare, with bonds secured by property, ANZ, a well-capitalised bank, and Wellington International Airport, a dominant corporate, have announced new issues. The first two discovered ample appetite for their offers.  I expect WIAL to discover full demand for its $100 million offer.

Oceania paid 3.2%, ANZ paid 2.999% and Wellington Airport is offering a minimum of 3.25%.

Investors would be smiling if their brokers were allocating even a scaled-down amount to every applicant.

More issues will follow, the Australian banks certain to be following the ANZ, offering subordinated notes at fixed rates for many years, and probably a renewal formula should the banks be denied by the banking regulator the right in any particular future year to repay in cash.

Now is a much better time to be updating fixed-interest portfolios, than any time in the past 18 months.

_ _ _ _ _ _ _ _ __

LAST week's Taking Stock gently chided the greed and incompetence of many receivers and liquidators, noting that the major accounting firms, like McGrathNicol and Grant Thornton, had behaved disgracefully with their tasks at South Canterbury Finance.

However, I should have richly praised Robert Walker, the clever, dogged, brave insolvency practitioner given the task of untangling the messes of David Henderson's contrived business failure at Property Ventures Group (PVG).

Henderson, it should be recalled, was the tax evader and serial bankrupt who claimed a victory against the Inland Revenue Department, decades ago.

In doing so, he could be likened to a sniper whose rifle managed to shatter a window before he was blown to pieces by armoured tanks, his subsequent battles with the tax department suggesting his initial one-shot hit was of no significance at all, if judged by the ultimate outcome.

Henderson had spent decades creating an illusion of creditworthiness that sucked in multiple finance companies, guided by a clever solicitor and aided by the oddball politician Rodney Hide, who has often praised Henderson, and sometimes invested in Henderson's structures.

Henderson's extreme use of debt, his almost total blacking out of transparency, his serial defaults, his back street cunning and the followers of his ZAP (Zenith Applied Philosophy) Scientology teachings, created a labyrinth that few insolvency practitioners could penetrate.

Unbelievably, a now-retired PwC accounting partner, Maurice Noone, then colloquially nicknamed the South Island Rainman for PwC, arranged for PwC to audit the Property Ventures Group mess, in return for 20, or maybe 30 pieces of silver.  Or maybe 10.

The failings of PwC in this audit process were blamed by the unpaid creditors when PVG was shown to have no ability to repay its $100 million (plus) creditors.  The audit process had been amateurish.

PwC's insurance policy, probably aided by the contributions of PwC partners, stumped up many tens of millions with an out-of-court settlement arranged by the insolvency expert Walker, whose case was part-funded by a litigation funder, LPF.

Whether the out-of-court, out-of-sight settlement was $30million or $60million has never been revealed.

Whatever, PwC's capitulation was a great victory for Walker, whose task was similar to searching for wedding rings in a myriad of blocked sewerage pipes, housing a resident crocodile.

Walker was a hero.

The PVG creditors had a return that must have been tens of cents of each dollar lost, thanks to him and his litigation funder.

So here is the punchline.

Walker, having successfully attacked a Big Four accountancy firm (PWC), is now dependent on a  licensing process determined by the accountants' institute. It is seeking to ban him from practising his craft.

After his monumental effort in dealing with a Machiavelli as a bankrupt, Walker's health was depleted. He has, at least temporarily, retired. His health may become a debating point seized by the panel which judges him.

Whether or not he is banned from practising, he should be honoured as one of the most courageous and persistent pursuers of a just outcome for creditors that New Zealand has ever seen.

Do you wonder why none of the big firms took on the task of tackling Henderson's mess?

Do the initials OBN ring any bells?

Do we really want accountants to be their own regulator, with the power to preserve an OBN that has served New Zealand poorly?

_ _ _ _ _ _ _ _ _ _ _ _

Johnny Lee writes:

The demerger of Fabric Property Group, an off-shoot from listed property trust Stride Property Group, will introduce a new listing on our exchange in early October.

An important point necessary to preface this article is to note that Stride - SPG listed on the NZX - is a stapled security and as such confers ownership of a group including Stride Property Group, which owns and leases property around the country, and Stride Investment Management Group, which manages property for various entities, including listed property trusts Stride Property Group and Investore.

A demerger occurs when a company ''spins off'', or structurally separates part of its business to create an independent, stand-alone entity. This is usually done when the objectives of the subsidiary no longer align with the overarching entity, in this case giving Fabric the opportunity to pursue growth in an avenue external to Stride's own objectives.

Other examples of demergers include Tilt Renewables' demerger from Trustpower, or South32's demerger from BHP Billiton in Australia.

Stride established Fabric late last year as a subsidiary created to own commercial property in the ''Office Building'' sector. Following the listing, Fabric will have a value (market capitalisation) of about $600 million, or a fifth of the size of Precinct Properties, another major listed property trust specialising in office space.

As part of the demerger, shareholders of Stride will receive shares in Fabric at no cost. Stride shares will fall in value, theoretically matched by the value of the Fabric shares themselves. In practice, market forces will determine the exact outcome.

The demerger allows Stride investors to either pursue an exposure to office property (buying Fabric shares) or ''town centre assets'' and property trust management (buying Stride shares).

Stride will retain a large minority (roughly 30%) shareholding in Fabric. While Stride has not entered into an escrow agreement, it has committed to hold the shares until May 2023.

Fabric has also elected to employ Stride Investment Management Group to act as its external manager.

One of the major issues with this structure is the obvious conflicts of interest that exist for the external manager. These are not hidden – in fact they are clearly highlighted on Page 47 of the 103-page Product Disclosure Statement – and the company will be very careful to ensure a robust policy is in place to minimise any perception of acting in conflict.

This conflict exists because Stride Investment Management Limited also manages assets for Investore and, more importantly, Stride Property Group. The Product Disclosure Statement cites the example of a central Wellington office building currently owned by Stride Property Group being sold to Fabric.

While the actual management of these conflicts is achievable, the perception is ultimately more relevant. For example, if said Wellington office building encounters problems after its development and sale to Fabric, Fabric shareholders would rightfully question whether their company is being treated as ''second-class citizens'' by the overarching management group. Stride will be aware of this and will be at pains to ensure that any process which concludes with a transfer of assets from one managed group to another is completely transparent and in the interests of both groups of shareholders.

Another issue with the proposed offer is the fees accrued to the manager. The fees are expected to equal about 16% of total revenue. These fees exist partly ''to incentivise the Manager to ensure transactions generate value for the Fabric portfolio'', a turn of phrase that is unworthy of anyone's vernacular, least of all a listed company. Imagine if Stride were to claim that they were not motivated or incentivised to manage Fabric in an optimal way.

These external management contracts have largely fallen out of favour among investors, due to the imbalance of risk and reward that inevitably occurs. Precinct was the most recent listed property trust to exit its management contract, buying out AMP Haumi Management Limited for $215m in order to manage its own buildings. Vital Healthcare's ongoing dispute with its external manager (Northwest) is well-known, and led to efforts from major shareholders to rein in the eye-watering fees charged by Northwest, presumably charged to incentivise them to ensure they added value as opposed to, say, not adding value.

Ironically, Stride itself is an evolution of DNZ Property Fund, which gained notoriety a decade ago following a dispute with its external management team, and had to pay more than $30 million to rid itself of an unwanted management contract.

Fees charged by Stride Investment Management Limited to Fabric include asset management fees, transaction fees, leasing fees, debt capital raising fees, property services fees, accounting services fees and, of course, performance fees. The offer specifically states that the fees cannot be changed by Fabric or Stride Investment Management Limited.

One must assume that, as part of its process of selecting Stride Investment Management Limited to the role of external manager, Fabric conducted a thorough and transparent tender process to ensure Fabric's new shareholders maximised the value of an external manager.

For Stride, the divestment is absolutely logical. The group was able to raise capital last November to purchase new assets, before selling them to investors a year later while maintaining an undeniably lucrative management contract. If Stride is to continue this path of incubating property assets before divesting on market, then shareholders of Stride will be pleased to see the accompanying growth in management fee income accruing to the group.

For potential investors in Fabric, the question one would ask is: why invest in Fabric over other, larger, more established owners of commercial office space? The company and its lead managers will now be pitching their argument for why Fabric is the superior choice.

Precinct Properties, while not necessarily a comparable peer, is an example of a listed property trust that invests in the prime commercial office space. Depending on how Fabric is priced, it intends to offer a dividend yield of between 3.6% to 3.8%, forecasted to lift slightly in future years to about 4.3%. Precinct pays a similar dividend yield (3.9% at time of writing) that is also growing, and has a market capitalisation about five times larger than Fabric. Obviously, other factors form part of the investment decision, but potential Fabric investors will logically be seeking a competitive advantage offered by Fabric over other alternatives.

Overall, the transaction is good news for investors wanting additional options to consider for investing in office property or property trusts. It is also good news for shareholders of Stride Stapled Securities, as it enjoys yet another lucrative management contract for its book.

Advised clients considering investing into Fabric, or those holding Stride and are about to receive shares in Fabric, are welcome to contact us to discuss further if they wish. We will also display our view on our client-only research page.


Chris plans to be in Christchurch on Tuesday October 26 and Wednesday (am) October 27. Any client wishing to arrange a meeting is welcome to contact the office.

If Covid allows, he intends to be in Auckland in early October and to conduct seminars in November, in North Shore, Auckland, Tauranga, Napier, Palmerston North, Kapiti, Wellington, Nelson, Christchurch and Timaru, and elsewhere if feasible.

Chris Lee

Managing Director

Chris Lee & Partners Limited

Taking Stock 9 September 2021

EVERY business that has ever had to write off a bad debt as a result of a receivership will currently be praying that Chartered Accountants ANZ (formerly the Institute of Chartered Accountants) is coming to the rescue.

Chartered Accountants ANZ (CAANZ) last week promised that the new regime for receivers and liquidators will lift standards for the betterment of all.

The new rules came into effect in September and place the accountants' institute in charge of deciding which receivers are competent, which are not, who should be granted the privilege of being ''licensed'' and who should not.

Once we get to the point where the accountants' institute sets the standards, the toxic behaviour that has so deeply damaged the reputation of insolvency practitioners would be a problem no longer, according to the CAANZ.

Let us hope the CAANZ is right. It will need a new, industrial-grade broom to sweep away the muck of the past.

The reality is that, with very few exceptions, the worst outcomes for creditors and shareholders during my 46 years of work in financial markets have been delivered by the major accounting firms.

If the country wishes to put the accountants in sole command of licensing, and make them the judge of what are acceptable standards, we should all assume the kneeling position and seek divine intervention.

I guess the thread of hope is that this new level of omnipotence, and omniscience, inspires the accountants to douse themselves in honesty and set about a cleansing of the rotten practices that have generated such cynicism and criticism, with practices such as:

- Selling assets without first creating buying tension, resulting in fire sale prices;

- Favouring the banks and other secured creditors by making minimal efforts to rescue money for unsecured creditors and shareholders;

- Selling assets to ''friends'' of the business;

- Paying unchallenged, often ludicrous, bills to third parties for their ''advice'' on legal processes or asset valuations;

- Allowing third parties to sell assets in a time frame that is convenient, rather than logical;

- Appointing small town receivers, ''friends from university days'' to ''assist'' with receiverships, a practice that discourages transparency;

- Refusing to sue trustees, bankers, lawyers, and errant directors who happen to have been influential in choosing the receiver.

These are all toxic practices; selfish, lazy, and greedy.

Of course not every receiver is guilty, nor are we without some excellent lawyers who fight for justice, rather than pursue ever fatter fees.

But we need solutions. I doubt the CAANZ will pursue change with vigour.

One solution would be to have a creditors' committee oversee processes and performance, and to grant that committee the right to fire the receiver/ liquidator/ statutory manager.

Another solution would be to have a judge rule on all rotten outcomes.

Another solution would be for creditors and shareholders to approve all charges, before they are paid, being especially vigilant with third party charges.

For many lucky people, there may be little understanding of how bad the process, and performance, can be.

So let us use an example;

Say a business fails owing the bank five million and creditors another five million. Let us say external shareholders had invested a further five million into the failed company, its cashflow ruined by bad debts and slow-moving stock.

So the bank cancels all credit and appoints a so-called reputable accounting firm as receiver, instructing the receiver that it wants its five million back within six months. As the secured creditor, the bank is effectively in charge.

The failed company has seven million worth of debtors, four million of stock, and three million of plant and equipment. The receiver quickly identifies that half of the debtors can be recovered by settling disputes, writing down the debts, agreeing to accept 50 cents in the dollar in full and final settlement.

The receiver discovers the stock valuation is unrealistic but that he can quit all stock immediately to a broker for 30 cents in the dollar.

So he will recover $3.5 million from debtors, $1.2 million from stock, making $4.7 million. The bank wants $5 million. The receiver, for all practical purposes, can charge what it likes fattening out bills, and can authorise third parties, like lawyers, to charge what they like. If $6 million is quickly recovered the bank, the receivers, and the lawyers can all be paid.

The receiver now has $4.7 million in cash and $3 million of plant and equipment. Along comes a friendly party – New Zealand is a small country – and wants to buy the plant and equipment.

''Give us $1.3 million and you can have it'', the potential buyer is told.

Within weeks the receiver triumphantly declares the receivership, or more accurately the liquidation, is cleared, the secured creditor paid in full, the receivership costs met in full.

Bad luck for creditors and shareholders. They will never learn what the debtors, stock, plant, and equipment might have been worth had an honest process been completed.

Now obviously I am conflating the processes of receivers and liquidators.

In theory the receiver, let's say a Big Four accounting firm, may hand over to a liquidator. Remember, in New Zealand we have a closely-knit Old Boys Network.

Would the liquidator be a corporate friend or a competitor who wants to highlight the insidious networks that produce these bad results?

There are some excellent people I have met in this murky world of receivers and liquidators.

One of them worked for BDO Spicers and was a gutsy street-smart character, who would not blink in a backstreet knife fight.

He retired early. His views would be interesting.

The controversial Auckland operator Damien Grant is another with a reputation for not blinking.

He deserves extra credit for having recovered from stupid errors in his life when he spent time in jail, but now uses all of his worldliness and experience to win applause from creditors and shareholders. The other receivers tried to ban him from a licence. They failed.

The lazy, fat corporate world has very few who prioritise returns for the secured creditors, the unsecured creditors, and the shareholders; not none, but far too few.

Will the accountants' institute now press for much better performance and for creditor overviews?

Or will they use the inept, lazy law changes made by the Ministry of Business, Innovation and Employment (MBIE) to ''paint a pig with lipstick'', as someone once described some of the moronic behaviour of those who so failed in their obligation to all parties when South Canterbury Finance was wound up by inept people, who retired as soon as their failures were visible.

Creditors and shareholders should adopt the kneeling position.

I suspect prayer is their best hope, until we have an MBIE and Commerce Minister with useful knowledge, energy, and a sense of justice.

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OF course, many in the privacy of closed boardrooms will opine that it is not only in cases of company rescue that accountants and lawyers are allowed far too much influence.

Though none are likely to speak out, the truth is that the companies that perform best rarely invite accountants and lawyers to have much presence in governance.

Science, technology, engineering, and production all regularly feature in the curricula vitae of directors running our best companies.

Genuine knowledge and experience, those blessed with analytical minds, those who understand strategic advantage, are characteristics of a successful company.

Accountants and lawyers might be called in for specialist advice when needed but real businessmen are in charge of developing strategy.

Such boards do not want corporate politics to intervene. They are not influenced by social commentators or irrelevant trends.

Evidence of this can be seen in the spectacular success of the country's most valuable, NZ-developed company, Mainfreight. Last month it was wrongly described as the first of our NZ companies with a share price of $100, an honour that Xero has achieved even if its shares are now listed in Australia (at A$150).

But Mainfreight's value is extraordinary, the more so in that just 17 months ago when Covid first arrived its share price was judged as being ''expensive'' at $30 a share.

Great credit goes to its founding chairman, Bruce Plested and its managing director, Don Braid, both of whom have been in their roles for decades.

The other directors are Richard Prebble, once, ironically a politician and a lawyer, Bryan Mogridge, Simon Cotter and a recent addition, Kate Parsons, who has expertise in technology.

The five NZ executive management team are all men who have been with Mainfreight for a decade or more, the four executives in Australia are all men who have been there for 10-30 years. The six executives in America are men who have been with Mainfreight for an average of 14 years. The executive in Europe comprises four men and a woman, who have served an average of 14 years. The four global executives are men with an average of 25 years with Mainfreight.

So what we have is New Zealand's most successful, truly global company, based in Auckland, its share price hovering around $100 per share, its profits growing steadily since it listed nearly 30 years ago. Like Fisher & Paykel Healthcare, it is a genuinely global company.

Mainfreight grows its own executives, its directors rarely change, its commitment to excellence is undoubted . . . yet it completely ignores some of the modern academic theory that seeks to assess excellence with academic criteria when reviewing governance and management.

Mainfreight displays intense interest in relevant social issues, such as climate change, water wastage, and social cohesion, but other goals of academia, such as the need to cater for others with diverse genders, lifestyles, and ethnic backgrounds, do not interfere with its pursuit of excellence.

Between its board of directors and its executive management globally, it engages 23 men and two women, all of whom, at least by photographic evidence, appear to be between middle age and what I would call ''senior'' age.

There seems to be no weighting for lawyers and accountants.

The biographies displayed all refer to relevant, private sector, business skills and experience. Wisdom is self-apparent.

Defying the so-called evidence of university studies into corporate excellence, Mainfreight displays a preference for knowledge, experience, commitment, and loyalty and has no policies requiring people to retire at any particular age.

Is it a statistical anomaly? Or is it evidence that an excellent company, relying heavily on culture and a commitment to long-term success, has better things to do than argue about academic or social theories?

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Johnny Lee writes:

THE soaring price of carbon observed over the past week has created a windfall for investors in the unique CO2 fund. The price per unit of the fund has increased almost 20% in the past two weeks alone.

CO2 is a listed instrument on the NZX, allowing anyone with a Common Shareholder Number to buy them, as they would any other share, and gain direct exposure to the price of carbon credits. The fund, managed by Salt Funds Management, has chosen to invest predominantly in New Zealand but does include a small holding of Australian carbon credits. The management fees are not inconsequential, perhaps reflecting the complex nature of the product and the lack of choice investors face for gaining such an exposure.

The introduction and operation of an Emissions Trading Scheme (ETS) in New Zealand has not been without criticism.

Criticisms have centred around the calculations of emissions, usage of international credits, exclusions of certain sectors and the effectiveness of the scheme as a way of actually reducing emissions, rather than simply increasing costs.

Nevertheless, the price of these units has soared in recent weeks, as companies seeking to pollute increase their ''allocation'' of our national ''budget''. Believers in a perpetually increasing carbon price – driven by a dwindling supply of credits and an increasing demand to own them – have been handsomely rewarded.

Of course, carbon credits have a value simply because we choose to give them a value. Carbon credits themselves do not create anything – they simply exist as a way of quantifying and pricing our national plan to reduce emissions and, hopefully, incentivising firms to actually reduce their emissions and therefore the additional cost the credits impose.

The fund had a slow start. For years, the fund saw little interest, and trading activity was extremely low. The price fluctuated between 90 cents and $1.10 throughout all of 2019, before lifting to $1.40 in 2020, before trading around $2 today. Millions now change hands each month.

Mechanisms exist to prevent these wild swings in price. This includes the ability of the Government to introduce a large number of new credits, effectively boosting supply to dampen the price. Thresholds must be met before this can occur – but these thresholds were met at the last auction and failed to cause a drop in price. Future thresholds to force more supply are looking increasingly plausible each day. The Government has stated that these increases in supply would be unwound in future years, meaning that although the can has been kicked down the road, there may be a race to pick it up soon.

In theory, supply and demand should also prevent such swings. ''Polluters'' have the option to target reductions to their emissions. However, it is often cheaper to simply buy the credits. For those earning carbon credits – primarily forestry owners – the increasing price should encourage activities to continue earning these credits. The increasing price suggests these sequestration efforts are not keeping pace with demand.

Last week marked the third auction this year. It was also the third time this year that demand greatly outstripped supply, and the third time the price rose to accommodate this imbalance. The final auction for the year will occur in December.

For traders and investors, the fund represents an opportunity to financially gain from the escalating price of carbon. As it is a political instrument, there are certain risks with the investment that cannot be mitigated.

And while it is not necessarily an investment into a traditional value-adding enterprise, market forces are driving the price upwards as New Zealand navigates its way towards its emission reduction targets.

_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

THE ongoing struggle between Philip Morris and global healthcare experts regarding the ownership of British firm Vectura is nearing a conclusion, with six days left for shareholders to decide whether to accept the offer or retain their shareholding.

Vectura is a developer and manufacturer of inhalers and is listed on the British AIM exchange. The company received a takeover offer from American private equity firm Carlyle Group, before Philip Morris, best known for its global tobacco brands, trumped the offer.

The board of Vectura later convened, and recommended shareholders accept the offer from Philip Morris. This led to widespread condemnation of the board from the healthcare community, urges to shareholders to reject the offer, and even a demand of the British parliament to block the takeover. Threats have also been made to blacklist the organisation from scientific forums if the takeover is successful. So far, no offer has been made from these groups to actually purchase the shares themselves.

Philip Morris, for its part, says the acquisition is part of a strategy to diversify away from its traditional business. Like other tobacco companies, Philip Morris has been under pressure from its largest investors to develop a strategy outside of tobacco sales. Some observers would see the strategy as a way to profit from treating a condition actively caused by its products. Others may see it as a business seeking a future away from a dying product. Jeers or applause will vary based on perspective.

Irrespective of one's stance, it does raise an interesting point regarding risk.

Biotech and pharmaceutical development companies are notorious for being hit-or-miss, not dissimilar in this aspect to the oil and gas sector. Although biotech companies can be enormously successful, the reality is that the overwhelming majority fail, either due to ineffective treatments and trials, cashflow issues or simply being too slow to create a product when racing a competitor to market.

This high failure rate is one of the main reasons why private funding is so common in this sector, especially in the latter stages. 

But does investing in a pharmaceutical company carry an additional moral obligation not found in other sectors? While oil and gas companies are praised for diversifying away from fossil fuels and towards renewable energy, are tobacco companies precluded from the opportunity to change their business model?

The story will conclude next week, when shareholders – the group with financial exposure to the outcome – vote to accept or reject the offer.

_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _


Our Paraparaumu office is open. However, we ask that anyone wishing to see us in person first make an appointment by email or telephone, to allow us to prepare a safe and legally compliant environment.

Level Two does allow city visits, within sensible rules regarding each meeting.

Kevin will be in Timaru on Thursday September 30 (pm) and Friday October 1.

Chris plans to be in Christchurch the following week, after recovering from his surgery this week, which was highly successful.

His seminars planned for November will be discussed once we reach Level 1.  Chris hopes to be in Timaru, Christchurch, Nelson, Wellington, Kapiti, Palmerston North, Napier, Tauranga, Auckland and North Shore.

Centres such as Hamilton, Dunedin, Blenheim, Masterton, New Plymouth and Whangarei will depend on client interest.

Clients are welcome to bring friends and family. Please advise by email if you wish to attend, where, and how many would be with you.

Chris Lee & Partners Ltd

Taking Stock 2 September 2021


MY warning last week to be cautious of mortgage trusts was prompted by a misleading advertising campaign that compared mortgage trust returns with the returns of a bank deposit.

That cunning strategy had been used by the worst financial product selling chains 20 years ago, when the likes of Money Managers were selling property syndicates and its awful First Step mortgage fund, triumphantly boasting that the projected returns were far higher than bank deposit rates.

The projected returns might have been superior, but the ultimate return of capital certainly was not!

So when First Mortgage Trust, based in Tauranga, began a recent campaign using the same strategy, it seemed to be wise to send a caution.

What followed has been interesting.

One of New Zealand's best business journalists is the Scotsman Tim Hunter, a pithy writer with decades of experience and a good memory. He deserves his wide audience.

In the National Business Review last week he compared mortgage trusts with the pre-2008 finance companies. The social media response was rapid and conveyed to me the message that the subject needed more discussion.

First Mortgage Trust, it must be said, has been a survivor, having had its fledgling years prior to the finance company sector collapse.

It has grown since then from around $100 million of retail deposits to a figure nearer $1 billion.

Because of its structure it sits outside some of the regulatory requirements of finance companies. Its disclosed information is not as helpful as I would like.

So here is a picture of it, a fair one, in my opinion.

Like all contributory mortgage trusts, First Mortgage Trust raises money from retail investors and lends it to people and organisations whose needs are not met by the banks.

Specifically it lends to property developers for short, sometimes renewable terms. It lends to them at rates much higher than bank first mortgage rates and often it charges additional fees. It may renew loans that delay their repayments. There may be renewal fees.

From the interest collected, but not the fees, it deducts its costs, deducts a separate management fee, and returns to investors the remaining interest received, currently about 4.75%, before tax.

Investors may withdraw at any time, forcing the trust to hold in cash perhaps $200 million to meet withdrawal requests.

So if $800 million of its $1 billion were lent at 9% and $200 million earned next-to-nothing, then the gross return, assuming zero bad debts, would be 7.2%, meaning its management fees and costs must be around 2.45%, a high but still credible figure. The gross return of 7.2%, minus 2.45% of deductions, creates the investor return.

The loan fees, which are not the same as interest, and are not shown, might be nearer 4%, if the fund were attracting the typical property developers, who would these days be paying at least 13% during the riskiest phase of their developments.

That would imply the owners of the fund are receiving returns of perhaps $30 million a year from their loan ''fees''.

Perhaps they discount the loan fees. I do not have the actual data. It does not have to be disclosed.

The ownership of the fund changed hands in recent years, with a group of men now owning the management rights, having paid an alleged $45 million to buy that right. The fund has grown rapidly and is now promoted heavily. The managers are doing well.

The new owners are said to be experienced in property development lending, having cut their baby teeth while working years ago with the likes of Equiticorp and Strategic Finance.

First Mortgage Trust has never defaulted.

Yes, we have been in an unusually buoyant property market in recent years, but its unblemished record earns a tick.

The fund has no capital, so must have a skill in sourcing reliable borrowers and collecting loans.

If it never defaults, even in downturns, it would be a great achievement, virtually, maybe literally, unique.

Those of us who have had long careers in financial markets could easily rattle off the names of allegedly skillfully-managed mortgage trusts that have defaulted. The reputable funds managed by Tower and National Mutual defaulted; the awful funds like Guardian Trust and Canterbury Mortgage Trust defaulted; the absolute shockers like Prudential, First Step, Burbery and Reeves Moses Investorcare destroyed investor money.

Multiple contributory mortgage funds run by solicitors have collapsed, some because of theft, some because of incompetence.

The finance company equivalents always claimed to have impressive capital but we all will remember the ''capital'' claimed by the likes of Bridgecorp, Lombard, St Laurence, Strategic, Capital & Merchant Finance, Dominion, MFS/Octavia, Hanover, South Canterbury Finance, Equitable & NZ Finance.

Their acclaimed capital was about as real as a seven dollar note.

The reality was the finance companies reported capital that did not exist, often claiming as ''capital'' retained ''profits'' from ''revenues'' that had never been, nor ever were, paid.

So it is fair to say that most finance companies were no better than contributory mortgage companies. It took the global crisis to shed light on those ugly people and companies.

Property development loans create extra risks because they can be repaid only if the development is consented, built, costs constrained within budgets, and finally sold at expected prices, within an estimated time frame.

Any interruption of any of these stages generally leads to a bad debt, especially if an incompetent or dishonest receiver gets control of the project.

If there is no capital to absorb the debt, the loss falls on investors.

If the owners of the fund have been siphoning off fat fees, instead of squirreling the fees to absorb future problems, the investors would have no protection when the property cycle changes.

My view remains that retail investors wanting to participate in property market returns would take much less risk for similar returns by buying units in the various listed property trusts, such as Precinct, Argosy, Property for Industry, Kiwi Property etc.

The very best property developers save their profits and fund each development with more equity, enabling them to keep control of their developments during the inevitable years of slow sales or market disruption.

They earn the respect of bankers, and they protect their creditors.

Ultimately they borrow at rates far lower than the rates paid by the more flamboyant developers, who are spurned by wise banks.

My conclusion: get advice before using contributory mortgage trusts or do your own homework thoroughly.

Mortgage trust returns are not comparable with bank deposits. The practice of using that comparison should be stopped by the regulators.

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THE Oceania Healthcare seven-year bond rate has been set at 3.20%, ensuring it will attract attention from investors.

Though bond rates are still relatively low, the uncertainties posed by the wide range of problems facing global economies does suggest that capital retention and some income will be an attractive option for many retail and wholesale investors, for a percentage of portfolios.

Oceania's model is based on quality housing and services for those of the retired sector that can afford the cost. It must be bearing extra cost, as it protects its residents from a Covid invasion, but like Ryman and Summerset it has plans for a long-term presence.

I expect its bond issue to be well supported.

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NEW ZEALAND is not the only small island that has had to grow its debt to help it ward off the economic effects of Covid 19.

Until Covid, my wife and I visited Malta for a summer sojourn each year for two decades.

It is a small country - two populated islands, total population half a million.

One of its business leaders has responded to my polite enquiry as to how it is managing Covid.

Currently 80% of the people are vaccinated. Nobody may enter or leave Malta without vaccination, unless they submit to a quarantine period. The island hosts each year around 10,000 secondary school students largely from Eastern Europe. The students brought the virus in a year ago. The new rules apply.

The government subsidises wages at the generous unemployment level if a company's turnover has fallen by 50% or more. It also pays the rent and electricity for such companies.

Twice the government has handed out 100 Euros to every adult to boost consumer spending.

Debt levels are higher, but still low by European standards.

The wealthy, controversial Prime Minister, whose mission was to stay in power and drag Malta into the 21st century, has gone, his power base undermined by alleged links to the businessmen who car bombed and killed a journalist who the business sector feared.

The new Prime Minister is 43, had been in the job only eight weeks when Covid arrived, and is seen to be progressive and regarded highly for his communication skills and leadership.

The opposition party is in disarray, outflanked by the relative success in keeping the economy intact. Unemployment is at its lowest level since records were kept. Wages are rising because of labour shortages.

Does much of this sound familiar?

It will be a day to savour when my wife and I arrive again at Luqa airport, hopefully in 2022, and hopefully with no heat waves scorching Europe.

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Johnny Lee writes:

WHAT a busy August!

Reporting season has concluded, a New Zealand household name may soon be departing from our exchange, three bond issues were announced from a broad spectrum of issuers and, of course, New Zealand has returned to lockdown.

Reporting season managed to paint a very bright picture of our economy, sending most share prices higher. Growth, in particular, is being rewarded. The likes of EBOS, Mainfreight and the retirement sector are sending our overall index to within a whisker of January's record.

Some of the results missed the mark. A2 Milk's result did not meet the low expectations already set following a series of negative updates. The company has made a series of one-off adjustments to manage its inventory in the face of falling demand from China. While A2 Milk remains profitable, the surging growth has stalled, prompting the company to conduct an internal review. Investors hoping for a result to restore optimism did not receive it. The company's cash reserve of close to a billion dollars will buy it time, but it must discover a new way to flourish in these conditions. The results of this review will be an important step.

Mainfreight's update yesterday, by contrast, only sent the stock further soaring. The share price briefly rose above $99 a share before settling back at $98. Every facet of the business is positively booming, across all regions the company operates within. It is a remarkable story of success, one that has been shared by investors in Kingfish, one of the listed Fisher Funds. Mainfreight is a large holding for the fund.

EBOS also saw another double-digit lift in profit while announcing two acquisitions and the construction of a pet food factory, bringing an external cost in-house and giving them greater control over a supply chain risk for the business. Such investments pay for themselves fairly quickly, and are typical of large, cash-rich businesses looking to squeeze extra value for shareholders.

I would contrast this strategy to stock buybacks, where a cash-rich company simply uses its money to buy back its own shares, inflating the share price, a tactic often employed by the finance sector to manage capital it considers ''excess''. As we have seen repeatedly over the past two decades, this is almost always reversed by capital raisings, at much lower prices, during the inevitable economic slowdowns.

For investors, the rising share prices on our exchange will prompt some to consider turning paper profits into real profits, by selling some of their shares. The decision to sell is often far more difficult to make than the decision to buy, especially in a low-interest rate environment where holding cash is unrewarded.

As prices rise, portfolios will tend to overexpose themselves to individual shares. Part of our role as investment advisers is to help manage these risks. Investment rules and regular reviews aid this process.

Clients wishing to discuss their portfolios are always welcome to contact us.

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ANOTHER trend developing on our exchange is a tightening of liquidity, as investment opportunities dwindle and cash reserves build. Z Energy's takeover – if it occurs – will further exacerbate this issue.

Kiwisaver is growing. The flight from term deposits, seeking higher returns, is not yet reversing. A Z Energy takeover, returning some $2 billion to shareholders, will undoubtedly need a home. What is needed – and what should be occurring – is new offers coming to market.

The expected Initial Public Offerings of 2 Degrees and Vocus (best known for its brands Orcon and Slingshot) should help alleviate this pressure. I imagine two profitable companies, with consistent and reliable revenues, producing sane dividends and avoiding terminal levels of debt, would be welcomed with open arms.

In this environment, it would be optimistic to ask that the shares be sold cheaply. Nor will they be sold until a pretence of aggressive growth – the telecommunications market in New Zealand has its established players, and making meaningful inroads against these companies has proven difficult.

The two are different. 2 Degrees is one of our three mobile providers, alongside Spark and Vodafone, although 2 Degrees has about half the market share (20%) of the two larger operators (40% each). Like Spark and Vodafone, it will be considering the best strategy in regards to the rollout of 5G around the country, especially in more remote areas.

Vocus competes in the broadband sector, which is dominated by Spark. Vodafone, Vocus, 2 Degrees and Trustpower have meaningful positions, competing on pricing, customer service and, increasingly, cross-selling of other products, such as electricity or streaming services.

These two particular companies will not appeal to all investors if they reach a decision on any IPO. The economic environment is not necessarily one where investors can exercise any degree of power in price setting. Some investors dislike investing into companies where the majority shareholder is an active seller. Over-enthusiasm can also lead to distortions, leading some to prefer to wait until after the listing has already occurred.

Nevertheless, we need more listings, and with asset prices this high, this may prove to be a win-win for both sides.

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We have suspended our city visits due to the nationwide lockdown. We hope to reinstate these shortly.

Chris Lee & Partners Limited

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