Taking Stock 10 October 2024

RARELY does it happen twice in a week but two of New Zealand's award-winning business journalists performed a really useful service for investors last week.

Pattrick Smellie raised the very topical point of transparency in the share markets, when short selling is relevant.

And Tim Hunter displayed his courage and observation skills when discussing the outcome of the dreadful rorting of investors when Intueri, a tertiary education provider, was listed in 2014. The outcome revealed last week was that the gutsy LPF litigation fund had succeeded in restoring much of investors’ capital from the insurers of the law firm and the accounting firm that blessed a quite dreadful prospectus.

With some help from the likes of the late Brian Gaynor, Smellie founded BusinessDesk, a grouping of an eclectic bunch of business journalists. He sold out to the NZ Herald, pocketing some handy shillings for his trouble, and is now the figurehead for the business section of the NZ Herald, if no longer the manager who looks after administration.

Of retirement age now, Smellie's career did involve a stint in the real world where he would have learned something about the challenges thrown at business leaders, whose task is to find solutions.

He wrote an important piece regarding the short selling of Spark's shares by opportunists who seek to exploit the fund managers who buy or sell based on indexed weightings of various shares. The involuntary trading is outlined in the covenants (promises) it makes to index investors, thus informing market participants of likely future buying or selling pressure.

This enables the non-index fund market participants to game the index managers, by preparing early for the forced buying or selling.

My thoughts on all of this are well known. I have been over-ridden!

In the case last week of Spark, the company has seen its share price slashed. The real fund managers lent their stock to short sellers. The short sellers keep selling far more than normal buying can absorb. The price slumps.

The index funds have to keep selling so the buyers at the new artificially low prices are exploiting the index funds.

What value does this add?

Smellie called for the NZX to require transparency in short selling, publishing weekly a list of all stocks that have been linked to short sellers.

The Australians have this level of transparency.

Perhaps the NZX CEO, Mark Peterson, can weigh the merits of Smellie's proposal.

The subject is very definitely important to investors. We know this from the level of daily communications we receive from investors.

Hunter's journalism was also an example of what NZ so lacks.

He is a veteran, a quiet sort in his 60s, like Smellie a multiple award-winning business journalist.

His enthusiasm for research is such that he is certain to have been offered much better wages to move to the large broking houses and be part of a research team. Presumably, he prefers the life of a business reporter.

He also has written insightful articles, revealing a good memory and a willingness to beaver away silently, sifting through documents.

Last week he noted that those who had been duped by the Intueri story 10 years ago have achieved compensation on the steps of the High Court. Funded by LPF, our only meaningful litigation funder, investors had challenged the veracity of the information published when Intueri raised around $170 million a decade ago.

The prospectus had described and promoted a tertiary institution funded by government grants, pretending that the rules that led to the grants were all being met. In truth the grants had been wrongly made as the claimed students enrolling for the courses were often not staying long enough to be eligible for Crown funding.

Chapman Tripp helped with the prospectus, lending its reputation to what was a phoney story.

BDO Spicers validated the numbers.

Only the most trusting investors, and the most careless fund managers, supported the capital raising. As was the case when TV3 was listed in the 1990s, most market participants could see the long-term outcome and left their purses fastened.

My guess is that the insurers of the directors, Chapman Tripp and BDO Spicers, put up a mighty fight, arguing that the Financial Markets Authority had implicitly endorsed the prospectus.

I surmise that LPF played hard ball, perhaps mentioning that a High Court hearing on compensation might lead to revelations that would be unhelpful to the defendants.

Whatever, the trial was called off and a very large compensation cheque was clearly paid. We know this because LPF would have refused any settlement offer that failed to reinstate most of the investors' money.

Hunter, in the National Business Review, explained all of this carefully, modestly not referring to his work years ago in which he identified all the anomalies in a prospectus that was almost the gold standard of dubious figures.

Hunter, like Smellie, has often walked where others feared to explore.

Nearly two decades ago Hunter edited The Sunday Times which wrote an excellent article to help investors, addressing insider trading.

Regrettably the article mentioned one character whose various skirmishes had never included any convictions for insider trading. He should not have been included in the list of villains that the article mentioned. The result was a defamation claim, an allegedly record-breaking settlement, and the end of an era when The Sunday Times had the stomach to have an authentic business section.

The decision to conclude coverage of real issues has never been reversed.

If I judge what interests real investors by reading the hundreds of emails we receive each week, I can faithfully say that the likes of Stuff virtually never seeks to attract the readership of real investors.

Smellie and Hunter deserve the respect of the capital markets.

Obviously they are excluded from boardrooms and have to work around the platitudes with which "business" people respond to the media.

Yet they raise real issues and rarely revert to quoting those platitudes.

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THE issue of gaming the index funds may also explain the extreme volumes and volatility in the shares of Santana Minerals in recent days.

This newsletter is directed towards our clients rather than the wider audience that reads it.

Our newsletter told clients and readers that Santana had been admitted to a very minor S&P Small Caps index as a result of its rising market capitalisation.

At the time around 2 million shares traded each week in a band of around 10 cents.

When the index news was published, the turnover doubled, and the share price rose by around 50%.

The public would know who bought the shares only if a buyer reached 5% of the share registry, at which point disclosure is required.

But there is no logical explanation other than that impatient involuntary buying by index funds, insensitive to price, using other people's money, led to this pricing anomaly.

Once the buyer or buyers had been sated, the price fell and at the time of writing was close to where it sat before Santana joined the Small Caps index.

From all this excitement what can one infer?

1. That index funds are vulnerable to gaming (remember Synlait's price reaching $15, Ryman $16), meaning those managing other people's money are not accountable for assessing value.

2. That lack of transparency enables market participants to exploit others (i.e. would sellers of Santana have held back from selling to obtain the full benefit of index buying rules?).

3. That price and value coincide, but not always.

Was the Santana price rise and fall caused by index buying, day trader frivolity, or a single undisclosed company wanting to obtain a 4.9% shareholding before the Crown showed its hand when it named those companies it intends to refer to the fast-tracking process?

Will we ever know? Believers in the long-term merit of Santana's project might ask "who cares?" Their attitude may be that in a year or two today's pricing games will have been long forgotten.

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THE sudden collapse in interest rates has NOT been caused by short selling or index funds.

Rightly or wrongly, those who provide the bulk of the money for bond issuers now believe that NZ's central bank will cut rates by two lots of 0.5% before Christmas, leading to a similar fall in bond rates.

Cash rates and long-term rates are not synchronised.

Cash rates matter, long-term rates move more slowly, but the reality is that benchmarks like the 90-day bill rate, and the separate subject of margins for risk, have a hefty effect on the rates that are quoted.

My guess is that the benchmark base rates may fall but the margins for risk may rise, meaning the likes of business lending rates may remain elevated.

I expect bank deposit rates to fall a little, perhaps to 4%, home mortgage rates to settle around 6%, but business overdrafts for medium-sized businesses to remain in double figures.

A slight fall in bond rates will help those who bought bonds at yields of around 2% after the pronouncements of the likes of Robertson and Orr warning of negative rates.

The trading banks spent more than $200 million to cope with negative rates.

Happily, sanity prevailed, and the money printing machines were turned off, meaning borrowers had to make sensible decisions, rather than just bundle up "free" money.

Remember Switzerland reached the point of LENDING at negative rates.

My expectation is that falling household disposable income, elevated unemployment, some degree of responsibility in government spending, and a slowdown in immigration, will lead to a period of lower inflation, lower deposit rates and slightly lower debt servicing costs.

Those who bought these 6% to 7.6% fixed interest investments will be relieved to have some years of above-market interest returns.

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Kiwibank - Perpetual Preference Shares

Kiwibank (KWB) has announced that it is considering making an offer of perpetual preference shares (PPS).

The PPS are expected to constitute Additional Tier 1 Capital for KWB’s regulatory capital requirements and to have an investment grade credit rating.

This investment is perpetual, with a likely redemption date in 5.5 years’ time.

The initial 5.5-year distribution rate has not been announced, but based on comparable market rates, we are expecting a rate of around 7.00% per annum.

KWB will be paying the transaction costs on this offer; accordingly, clients will not have to pay brokerage.

More details are expected on 14 October.

KWB has a strong credit rating of AA.

If you would like to be pencilled in on our list, pending further details, please contact us promptly with an amount and the CSN you wish to use.

Indications of interest will not constitute an obligation or commitment of any kind to acquire this investment.

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Travel

I am to talk to a group in Arrowtown on Nov 14 and will enjoy meeting individually with clients before the 3.30pm meeting. I have available times from 11.30am to 2.15pm.

16 October – Albany - Edward Lee

18 October – Ellerslie – Edward Lee

29 October – Takapuna – Chris Lee

30 October – Ellerslie – Chris Lee

14 November – Arrowtown – Chris Lee

Please contact us if you would like to make an appointment to see any of our advisers.

Chris Lee and Partners Limited