Taking Stock

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TAKING STOCK 14 December 2017


REFLECTIONS on the 2017 calendar year must start by repeating that there was no global sharemarket collapse, interest rates did not rise, indeed they fell in New Zealand, and savers continued to ignore risk.

Investors who make conscious, reasoned decisions may not have ignored risk but all those savers who simply loaded up the index-buying funds clearly fell for the big lie, that any time is a good time to buy any security.

We now all know that these observations are not just sourced from a seaside village north of Wellington.

The Bank of International Settlements (the central bank for all central banks), has this month observed that risks are being ignored.

This warning is far weightier than any message from any market participant where the motive might be click bait, or a marketing device, as the Royal Bank of Scotland displayed two years ago.

In 2017 much has been made of the risk posed by inappropriate people in leadership roles, in places like North Korea and the USA.

Much has centred on other trouble spots, the usual suspects being places like the Gulf, Russia, South America, Central Asia, Europe and Africa.

Currency wars, trade wars and real wars remain an unpleasant potential outcome, probably stemming from over-population and inequality in many countries.

These add to the risks that investors consider.

Also adding to the risk are those who indulge in cyber-attacks and those who continue to pollute our oceans, soils, atmosphere and waterways (Lake Taupo!).

Here in New Zealand, risk has wrongly focussed on the cost of houses in our most desired suburbs or towns.

Xenophobes and silly politicians have sought to gain votes by blaming ‘’immigrants’’.

Many, indeed most, immigrants are looking for what we spoilt New Zealanders see as modest jobs supporting modest aspirations, in tasks like broadband connecting, road works, construction, farm work, orchard work and rest home care.

Without immigrants these tasks would be left undone.

I do accept that we do not need itinerant pompous pillocks, having failed in their own country, to come here to borrow big time to acquire and then arbitrage mundane assets.

We do benefit from wonderful newcomers, like Julian Robertson and his late wife, whose aspirations are altruistic, and who are not self-acclaimed, faux philanthropists.

New Zealand investors have had a relatively attractive menu in 2017, able to achieve returns of between three and four per cent with very little risk, perhaps in bank deposits.

Equity investors have done much better, double figure returns being commonplace.

Success has come to those of our listed companies which produce core products or services – the likes of Spark, the power generators/retailers, the banks, the ports and airports, and those who facilitate export.

The retirement village sector has provided rich capital gains and is starting to release dividends to investors.

The listed property trusts have largely been in de-risking mode, reducing debt levels and lengthening tenancy terms.  This sector has performed well.

One can be grateful that none of the listed trusts are making the mistake that amateurs make, gearing up to acquire during market peaks and venturing into property development.

To those who have had careers that span different cycles, patterns may appear but as the past is not a reliable guide to the future the patterns are not a foolproof guide.

It will be obvious to all that over-population and ambition often lead to stress on our natural resources.

Obvious symptoms of stress through excessive exploitation of natural resources have been visible in the fishing industry, the dairying sector (animal health, pasture health, waterway health) and the building sector (human errors everywhere).

It would be unwise to ignore the dairy herd health problem in South Canterbury and now in Hastings.

Until it is contained and animal health has been prioritised, there must be concern, dairy exports being of such importance.

Fixed interest investors ought to be interested in the levels of liquidity in the bond market.

They should also care about the compression of margins, providing very little extra reward for borrowers whose credit rating imply greater risk.

In recent weeks we have seen Christchurch City Holdings Ltd raise money for five years at 3.4%, the KiwiSaver and other fund managers being the biggest buyers of this security.

We have had bond issues from three well-run listed property trusts, the first, Property for Industry, paying 4.59%, Precinct Properties 4.42% and now Kiwi Property Group will pay 4.33%.

KPG has a BBB credit rating, yet its seven-year bond is paying barely more than the AA-rated banks are paying for five-year term deposits.

Yet there are valid reasons why a retail investor might choose KPG.

The answers will include diversification, transferability (liquidity) and the secured nature of the bond, from a company with extremely low debt.

However, the question does point to a trend that reminds me of previous cycles, when there was similar compression of rates, sometimes little or no distinction between the best organisations, slightly lesser ones, and poor operators.

Recall how in the 1980s the dishonest contributory mortgage company RSL Securities would knock on the doors of pensioners and get them to shift term deposits, then earning 18% with their bank, into contributory mortgages at 22%.

The money was lent by RSL’s crooks to some sound propositions, like hedgehog racing clubs based on Somes Island, to help build grandstands (or some such nonsense).

RSL, like the Money Manager’s First Step rubbish, never offered a premium that even vaguely compensated the underlying risk.

Both were extreme examples of a compression of margins that denied return for risk.

Investors may perceive that the corporate bond market today barely offers enough margin over bank deposits.  This seems unlikely to change in the near future.

Of course, the residential property market also sends signals that are confusing.

How can people on average salaries afford to live in our best suburbs?

Indeed, is it even a logical aspiration for people who do not regard high income as their prime priority?

If a bank team leader, earning $60k per annum in Dannevirke or Greymouth, was offered promotion to Auckland’s North Shore, and a pay increase to $100k per annum, would the banker take the promotion?

If the banker understood maths he would stay put.

The NZ equity market, seen to be vulnerable by those who focus on price to earnings ratios, would undoubtedly collapse if bank deposit rates, or bond rates, rose to 8 per cent.

But there seems no chance of such a rise in interest rates, nor could a meaningful rise occur without quite disastrous consequences, worldwide.

The global focus on ZIRP (zero interest rate policy) is unwavering.

A global sharemarket ‘’collapse’’ rather than normal ‘’corrections’’ is not impossible as emotion drives extreme behaviour and fear can be triggered by an infinite range of events.  However it would seem odd if a company with sustainable revenues, margins and dividends suddenly saw its share price collapse.

The key word of course, is ‘’sustainable’’.

In New Zealand most people assume that the power generators/retailers, the banks, and the major providers will be selling their services profitably, and delivering steady dividends, for many more moons.

If Spark, as an example, saw its share price halved to $1.80, its dividends of perhaps 30c would be offering 16% returns.

I would keep my finger on the buy button.

Fear of property price collapses would assume a collapse in demand, perhaps caused by a huge rise in unemployment with a simultaneous reversal of immigration demand, combining at a time when ten thousand builders were completing their apprenticeships.

Fear of a NZ standalone market collapse would reflect a huge leap in interest rates, an uncontrollable rise in unemployment, a biosecurity failure affecting animal health, or, even more improbably, bizarre political behaviour.

A market collapse globally would lead to a loss of foreign investment in New Zealand which would impact liquidity, and therefore prices.

In my view investors must always arrange their affairs so that they can survive market volatility but an absolute disaster, like a nuclear war, would test the readiness of any survival plan.

Investors ought to focus on what they can control, and one obvious example is the costs they will pay to invest.

Everywhere the cost of intermediation (advice, funds management, transaction costs) is being camouflaged by clever strategies.

Many in my industry expect that ‘’brokerage’’ will eventually be abandoned after investors have accepted a replacement ‘’annual fee’’ for access to advice, research, and new issues.

In essence this camouflage is saying ‘’pay me 1% per annum and I will charge you less, perhaps eventually no, transaction fees’’.

A very competent and honest market participant explained to me recently that such a charging mechanism would end the practice of ‘’churning’’ equity portfolios.

He noted that there would be no incentive for the third-tier ‘’advisers’’ to churn if there were no fees earned by churning.

His words were no doubt accurate and honest, but still nauseating.

Until fees, calculated as a percentage of a portfolio, are omnipresent, investors ought to be examining the issue, using as a guideline ‘’value add’’.

In assessing the ‘’extra’’ return from good advice, they should also make an adjustment for ‘’extra’’ risk.

The adviser in Lower Hutt who sold a client’s government stock to buy Feltex shares might have added ‘’return’’ had Feltex survived but he would have done so at the expense of risk, as, sadly, the investor discovered.

My personal view is that transaction fees are much fairer, and more cost effective for the client, than an annual fee based on portfolio value.

It remains inexplicable to me that investors will accept annual fees paid on their cash and bond portfolios, the ‘’fee’’ often eating a quarter or even a third of the revenue.

To pay brokerage rates and a hefty annual fee seems unwise.

In 2018 I have no doubt many more investors will be pondering these multi-thousand dollar annual fees, especially if 2018 is a year, an overdue year, when returns are lean or negative.

Investors should also consider the fees they pay fund managers and especially they should review the ‘’bonuses’’ they allow fund managers to take when the returns surpass a defined benchmark.

How can TSB keep a straight face over the bonuses from its Fisher Funds subsidiary, when the bonus formula is manifestly absurd?

Investors cannot control returns, they can address risk by using appropriate asset allocations, (though credit risk is still a threat) but most of all they can address costs, by demanding that fees are not just calculated lazily and extravagantly as a high percentage (like 1%) of a total portfolio.

The other risk investors should consider is the potential failure of those who should be guardians for investors, preventing poor behaviour.

The Financial Markets Authority, the auditors, occasionally trustees, directors and fund managers have imperfect histories.

The FMA’s predecessor, the Securities Commission, despite a few individuals standing tall, was still an example of an inept regulator, lazy, ineffective, under-funded, and guilty of cowardice in its intended role of stomping on the heads of cheating companies.

This guilt goes right back to the 1980s, when it allowed bullies and liars to ignore the intention of the laws, Colin Patterson a rare exception who would not tolerate bullies.

The NZX and the FMA are today more robust organisations but we still observe compromises that make little sense.

Personally, I would prefer that bad behaviour is referred to the High Court, rather than dealt with by ‘’settlements made without admissions of guilt’’.

Audit standards are variable, partly, I suppose, because of some idiotic accounting guidelines to companies ‘’regularising’’ their results, often on subjective matters.

How did Powerhouse Ventures Ltd ever get approval to run a prospectus in Australia that used an utterly misleading, unarguably obsolete, valuation of its biggest asset?  And still there has been no announcement of a prosecution!

Trustee companies are now licensed but the criteria for a licence is far too loose, in my opinion.

This role should be for staid, bureaucratic, boring but fastidious people, modestly paid to do a low-value job.

It is not a service that should be controlled by flamboyant entrepreneurs seeking to buy, grow and then sell, leaving another entrepreneur to do it again.

If I were the licensor, I would place much emphasis on the stability and constancy of the licensee.

Clients of trust companies must take matters into their own hands.

Never sign up with a trust company without establishing the uncontestable right to sack the trust company.

A clever person might put a maximum number on the total annual charges, perhaps of $1000 or some similarly modest sum.

Trust companies will never have meaningful value-add, they are nowhere near the gold standard as fund managers, and should be a last resort as a manager of trusts or estates.

This is an area where people can stop cash wastage.

Director behaviour should also be monitored.

I expect the standards of boardroom behaviour will improve as the NZ Shareholders Association gains in gravitas.

Sadly many New Zealand companies still allow directors to live with a feeling of entitlement. Feudalism remains in many mindsets at board tables.

Competence, integrity and complementary skill sets are what an investor should seek, along with experience and relevant knowledge.

The concept of filling up boards with retired politicians is absurd.

Commerce has disciplines utterly different from politics.

The likes of John Key will have relevant experience but academics and politicians, generally speaking, are rarely relevant.

I still recall the days when senior bankers were often more like politicians than businessmen, and were as much use around a board table as carp fillets in a fish shop.

One such banking goof once wasted fifteen minutes of board meeting time telling me that my request for an 8% wage increase request on my $800,000 staff bill was not worth discussing as it involved only $6,400, and continued to fiddle with his calculator after I politely pointed out that his arithmetic was incorrect.

Directors need candour, vigour, rigour, valour and intellect just as a great CEO needs these qualities.

New Zealand went up a gear when Sir John Anderson brought these qualities to banking in the 1980s and 90s.

So in 2018 investors will face uncertainties that will give the investors the least grief only if they address these issues with careful thought, perhaps discussing them with competent advisers who charge a fair price.

My guess is that those NZ investors who can succeed in collecting the desired level of income, and retain their capital, will not feel dissatisfied when they review 2018.

It might be a challenge in 2018 to do much better than this.

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THE search for more female directors is not helped by instances of female director incompetence, as displayed by former politician Jenny Shipley.

Shipley chaired Mainzeal, an appalling company whose tribulations were obvious to everyone but its board of directors, it seems.

She would do more to advance the case of women as directors if she resigned from all her directorships now, setting an example of accountability for abject failure at Mainzeal.

She is far from the model that aspiring female directors should follow, in my opinion.

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INVESTORS who seek to avoid errors will have had no pleasure at all from observing the meltdown of Powerhouse Ventures Ltd (PVL).

Indeed many in the markets openly supported PVL for several years, believing it had the capacity to nurture a stream of good ideas into a few successful, innovative commercial operations.

The hope was that it would help entrepreneurs achieve scale, generating jobs, showcasing some clever New Zealanders, and helping new companies to build wealth.

A large group of BNZ financial market specialists supported many of the projects and I too provided capital for what seemed like potentially exciting ideas.

To achieve success PVL needed a group of smart, wealthy, experienced and available people to provide all the necessary help for a pathway to success.

Innovation, entrepreneurship, and academia rarely have much clue about matters like capital-raising, banking solutions, necessary governance and management structures, exporting, personal development, patents, premises etc.

Sadly, PVL pretended it had the people with these practical skills. These people may have had good intentions but they were goofs, and accepted rewards well before the rewards had been earned.

In reality it had a group of people, some of whom had no real wealth, few of whom had ever built companies, and some of whom seemed to be takers rather than givers.

The nett result has been failure, destruction of potentially great companies, and at very least major setbacks in timing for virtually all PVL’s ‘’incubated’’ companies.

Far from accelerating progress PVL has delayed it.

It is now chaired and managed by Australians whose brief contact with me gave me no confidence that PVL could be re-established.

I have sold my PVL shares and have chosen not to contribute money even to the potentially good concepts that the likes of Invert Robotics have showcased.

There has been no published progress on the regulators’ investigation into PVL’s flawed prospectus, no sign of accountability for fundraising that was undeniably mis-described, perhaps cynically.

PVL’s managing director Stephen Hampson has vanished, probably asked to carry the can that could just as easily have been handed to any of the board members who signed the PVL prospectus.

New Zealand has many so-called incubators, the Morgan family among them, where there is a combination of money, experience in building companies, and some intellectual grunt.

At one end will be the likes of FNZC, in the middle will be various opportunists who seek to attract other people’s money and generate fee income, and there will be experienced companies like Rangatira, where there is real money and a history of supporting companies that are in the final stages of their development.

The NZ Venture Investment Fund has a patchy record, again lacking the ultimate accountability of being stewards of their own money.

Coming around in a few weeks, 2018 will follow many years of handsome, easy gains, when many investors and fund managers have recorded victories without much effort.

In cricketing parlance they have been batting against a bowling attack that delivered half trackers and full tosses.

They may face a more hostile attack in 2018.

There will be no room for the likes of bumblers like Powerhouse.

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Urgent for investors in Hanover Finance, United Finance, Hanover Capital

ANYONE who invested or reinvested in any of the above companies AFTER DECEMBER 7, 2007 is entitled to a part repayment.

Those who invested BEFORE December 7, 2007 are NOT entitled.

Entitled are those who invested, or re-invested, in Hanover Secured Debentures, United Finance Debenture or Hanover Capital bonds AFTER December 7, 2017.

These investors are entitled to:

Hanover Finance debentures – 16c in the dollar

United Finance debentures – 19c in the dollar

Hanover Capital – 6.8 cents in the dollar

If any investor who is eligible and has NOT communicated with Deloittes, which is managing the repayments, must email nzhanover@deloitte.co.nz or phone 0800 426 683 before 16 February, 2018.

Investors after December 7, 2007 are eligible because they were misled by a prospectus dated December 7, 2007.  The directors and their insurers have paid a sum in recognition of these errors.  That money is distributable to eligible investors.

Please check your records to see whether you are eligible.

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Holiday Arrangements

Our office in Paraparaumu Beach closes at 5pm on Wednesday December 20, in Timaru at 5pm on Friday December 15.

Kevin (0276888702), Edward (0274778474) and Chris (021838561) are happy to assist with urgent needs until the office reopens at 9am on January 8, 2018.

This is the last Taking Stock for 2017.

May the Christmas and holiday season bring joy, good health, and clean the slates for a successful 2018.

Chris Lee Managing Director

Chris Lee & Partners

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