Taking Stock 22, April, 2021
David Colman writes:
THE promise of a ''guaranteed'' income ''for life'' has been exposed as false this year.
Lifetime Retirement Income closed the Guaranteed Income Fund after less than 5 and a half years since it was launched on 15 December 2015.
The similar Simplicity Guaranteed Income Fund has followed suit.
The Guaranteed Lifetime Annuity products together mustered about $200 million dollars under management after being heavily promoted by questionable financial 'advisers', perhaps paid to attend seminars and sell what they may have misunderstood.
In January of this year, the Reserve Bank of New Zealand asked Lifetime Income Limited to raise more funds as regulatory capital but the firm could not find a way to raise the amount required (approximately $10millon) by the deadline of 30 June this year.
In the context of financial markets, the failure to find such a sum implies a weak level of shareholder wealth.
The RBNZ would have been aware of the fund's lowly credit rating of B, several grades below a satisfactory rating.
In 2018, while the guaranteed funds still existed, Retirement Income Group (RIG), the company behind the Lifetime Income Fund, released an information memorandum to shareholders, existing and potential, with answers to the question of, 'why invest in Retirement Income Group Limited?'
An apparently simple answer was that RIG could charge hefty fees to manage people's savings and charge to insure that regular income so it might be paid after the savings were depleted. High returns to shareholders seemed possible.
So although I am disappointed for investors that were enticed by a 'guaranteed' income 'for life' which was initially offered at 5.0% per annum at retirement age of 65 (the original offer to 60 year olds was 4.50% per annum and up to 7.50% for 90 year olds) I am glad the same investors have a chance to evaluate their next step.
The memorandum described the retirement income industry as arguably one of the greatest opportunities for the New Zealand financial services industry, indicating that 400,000 Kiwisaver members with more than $36billion in assets would be in a position to transition to annuities in the next decade.
The insurance component, now being dropped, does not change the opportunity described above for ambitious fund managers/promoters so it is little wonder a replacement annuity is now touted minus the insurance component.
RIG has simply foregone the insurance component yet can still charge a fee to pay people a portion of their own money back to them in the form of regular returns from their managed fund.
The intention of providing an insured income for the rest of someone's life may have seemed admirable but from an investment perspective a variable annuity product, using the Guaranteed Lifetime Fund as an example, exposed participants to substantial fund management fees of 1.00% per annum and insurance fees of 1.35%.
If someone with $100,000 entered the scheme at 65 and lived to 90 then they would have paid tens of thousands of dollars for management fees and insurance to the managers over 25 years, an absurd percentage of their money.
Without the insurance cost the new notably higher management fee of 1.35% (why is this fee higher?) on the replacement unguaranteed fund for a 65 year old living to 90 would still pay many tens of thousands in fees on $100,000 in the fund over the 25 years.
Note: A person could draw down $4,000 (4%) a year from their own $100,000 for 25 years and not lose any of the principal in fees, a fairly logical, and superior, alternative but certainly not the only option.
The costly insurance component in the end didn't protect scheme members from the very things that the fund was promoted to protect them from, such as not having to worry about market crashes or low interest rates affecting their income even if achieving extended longevity.
Lifetime fund director Ralph Stewart indicated that very low interest rates, the uncertainty of Covid-19 and extreme market volatility contributed to the RBNZ requiring additional regulatory capital to be held by Lifetime Income Limited.
Covid-19 once again is easy to blame but in my view events such as seen in 2020 were likely to happen, and happen again, during the remainder of the Lifetime product for most participants.
Potential clients may have been more astute than the company estimated.
It looks like the insurance to guarantee income for the rest of someone's life that relied on returns from bond and share markets became too costly in the face of stubbornly low interest rates, less income from dividends and more volatile markets.
Optimistic assumptions of achievable fixed annual rates of return, that were estimated to be able to be guaranteed by the founders of the Lifetime scheme when it started, have unfortunately proven unrealistic, just as experienced capital market people predicted.
As a member of the New Zealand financial services industry I see the large numbers of Kiwisavers reaching retirement in a different way to that described by RIG in its memorandum.
I view the trend, more as an investor myself, in that Kiwisavers at retirement age and beyond have the opportunity to free themselves from the fund management fee machine.
Simplicity joined forces with The Lifetime guaranteed fund in 2017 and its founder, Sam Stubbs, described retirees' investment options as limited to low-interest term deposits or too-risky investments that offered higher returns. He said this when promoting the Simplicity guaranteed fund which has also been scrapped.
His views were either blinkered, or seen through a self-serving prism.
I can confirm retirees have a vast array of investment options available. A self-serving fund manager is simply ''selling'' when he suggests otherwise.
As the guaranteed fund has proven, no investment is without risk but disciplined and well-advised investors can manage their own portfolio with low ongoing costs and have great control of their own finances.
Not much is guaranteed in life and certainly no investment can be guaranteed for life no matter how long that may be.
An annuity is a complicated investment product. The initial investment in an annuity will decrease every year, influenced by fees, the performance of the underlying balanced fund and the amount paid in the form of fortnightly payments. Inflation will also eat away at what the income can afford.
I am relieved that annuities remain a niche and avoidable product in New Zealand.
_ _ _ _ _ _ _ _ _ _ _ _
Chris Lee writes:
FOR all investors, including a social government, a key question now is whether or not it is too late to invest in property.
For some the issue is whether we can avoid inflation and thus avoid much higher mortgage rates, reducing the value of the investment. Those with no debt welcome inflation. It is a factor in the growing value of assets like property.
For some the issues are related to the consequences of rules made by people with usually very little experience in property investment. It is hard to have confidence in those rushing through new law in pursuit of approval from their electorate.
We all know New Zealand has three major problems in residential property, and we know a Labour government will not be constrained by a shortage of funding. Money for social housing is freely available at low cost.
The key questions are:
1. How to make property available to those on an average income;
2.How to coax those who have no access to shelter into a more optimistic and hygienic lifestyle;
3.How to ensure that those who are renters can have access to an acceptable standard of shelter, at a fair cost.
The third problem is easy to solve.
Go to Malta and discover how its government incentivises landlords with tax concessions granted only to landlords who sign a ''good landlord'' contract. Incentives generate better behaviour. Punishment just creates antagonism and encourages avoidance.
The second problem is easy. Build extremely modest, cheap, lock-up units and give them to the homeless. Go to Germany and observe the gibbed out, wired, warm, shipping containers, built with a tiny kitchen and bathroom and a decent bed. All but the most damaged people would prefer this to living under cardboard boxes, as so many immigrants do in Brussels, as just one example.
The first problem can be resolved by visiting Britain or the USA where they have displayed a model that works. This solution requires careful thought but, in headline terms, here is how that solution has developed.
Their equivalent of our Housing Corp/Kainga Ora buys up land, often recreational land that was used for community sports in the days when most people enjoyed activities such as golf, tennis, football, or even sunbathing. Sequester the land. Provide alternatives for the users.
In New Zealand terms, buy out one or two of Timaru's barely used golf clubs, facilitate the transfer of the members to another club, and use the land to build 1000 dwellings. (That is the number you would build, for example, on the land occupied by an 18-hole golf course.)
Raise money with a 2.5% issue of Housing Corp bonds. Indeed raise billions. KiwiSavers, especially the index funds chained to indices, would provide money by the wheelbarrow full, even if the interest rate was close to zero.
Build $450,000 modern, dry, appropriate townhouses and build on the perimeter a car parking building so home carparks become obsolete. Buy the land near available employment and near transport hubs.
Sell the townhouse that costs $450,000 only to those needing social housing, or affordable housing, but sell it for $250,000.
Ask for no deposit.
Lend the money at 3% for 25 years.
The mortgage repayments will be fixed at a third of median household nett income, so repayments are affordable.
Here is the key.
Impose a covenant which restricts the new ''owner'' to first offering any re-sale to Kainga Ora, at a price that is serviceable by 100% debt-funding at the same percentage of median income as the first buyer paid, that is, a third of nett median income.
So if in 10 years the median income has doubled, and mortgage rates have remained the same, then the capital gain for the first buyer is restricted to what the maths will dictate.
Meanwhile, Kainga Ora records the asset (the house) at cost price, never writing off the ''loss'', offsetting that loss because of the value of the right to buy the house back at a set formula.
Build enough houses over say, six years, to swamp the demand. Create the builders by swapping no-cost tertiary education in construction for a five-year promise to work for Kainga Ora.
The solution would require a new acceptance that much of our recreational land now is barely used, and will be even more redundant, as the numbers playing team sport diminish.
Build skateboard parks or basketball hoops, or hip-hop dancing platforms, but do not kid yourself that one day young people will return to team sports that require coaching, practice, discipline and, most of all, the time to play on given days at pre-determined times.
So in summary:
- Go to Malta to learn how to constrain rents without constraining supply.
- Go to Germany to discover humane policies to help those whose aspirations have been destroyed.
- Go to Britain to discover how to change laws enabling the Crown to sequester land, provide modern houses at affordable rents, fund them with bond issues, and gain your return from a mix of your buyback rights and the satisfaction that the improved ''well-being'' of your population provides a meaningful return.
Leave all other housing provision to the private sector which will match market demand with a profitably priced supply.
NZ has some outstanding people in Kainga Ora.
Use them and use good strategies before they lose their energy under the pile of political indolence and incompetence that buries so many solutions, perhaps because of the oxymoronic expectation that public sector/political people have any capacity to visualize AND EXECUTE good ideas.
_ _ _ _ _ _ _ _ _ _ _ _
TO complement the above plans, and ensure the plans can be executed, one more initiative would be required.
Our high schools would need to revert to the mission of preparing its students not just to be kind and inquisitive, but also to align their programme with available and useful vocations, so they can advance into real life.
That programme would ensure those high school students in rural areas might learn about meteorology, animal welfare, environmental hygiene, machinery usage, and a host of subjects more useful than ancient religions or solving quadratic equations.
And those with an aptitude for manual work might complete their NCEA in subjects that include construction.
_ _ _ _ _ _ _ _ _ _ _ _
INVESTORS in the cynically managed Canterbury Mortgage Trust (CMT) have had their final repayment, bringing total returns, after 12 years of recovery, to around 93 cents in the dollar.
Those who have managed the recovery have recovered more than most from other mis-managed funds. CMT, it should be recalled, was established by lawyers in Christchurch to do the type of lending that used to be performed by solicitors' contributory mortgage funds, or from their trust accounts (in earlier decades).
CMT promised to lend on real property (houses, buildings) and not on developments, and definitely not to those who represented extreme risk, like the serial defaulter David Henderson.
Governance of the fund was to be performed by Fund Managers Canterbury, a group of solicitors aided by at least one salesman of retail investments, one-time cricketer, Paul McEwan.
The governors broke their own rules, lending on property developments and to the likes of Henderson, thus imperiling investor funds which, when the fund collapsed in 2008/9, held $240 million (approx) of largely Cantabrian money, nearly all channelled to CMT by Christchurch financial advisers. One does not imagine that these advisers were not being incentivised to recommend the fund.
To be fair to those advisers, most were from an insurance or real estate background and would have simply trusted the solicitors in charge to adhere to the rules. Such advisers, common before advisers became licensed, were not selling knowledge, and not conducting useful due diligence. Nor were they monitoring the behaviour of the fund.
When the CMT recovery began, the liquidators sued the various governors (Funds Management Canterbury) and succeeded in obtaining a confidential settlement, which is believed to be around $6 million, a trifling sum given the magnitude of their errors.
I regret that a High Court did not hear the case and give its view on the liability of the directors.
In today's environment, I would expect such an award to be far higher, but we have to accept that today's expectations of competent governance are rather higher than they were in 2009.
The CMT investors were repaid around 93 cents in the dollar, not including a small tax refund which differed amongst investors, depending on their personal tax rates.
The recent final liquidation report ends the subject.
What remains is the lesson.
My summary would be not to use contributory mortgage funds, but certainly not those whose governance is dominated by lawyers and financial salesmen.
Very few lawyers are streetwise, astute moneylenders, just as very few are of much value in weighing the risk and return of business investment decisions. Their skill and expertise is in paperwork, not in assessing creditworthiness.
Financial salesmen are rarely useful directors, as we saw with Nathans Finance and Money Managers, in previous decades.
_ _ _ _ _ _ _ _ _ _ _ _
Johnny Lee writes:
NEW Zealand investors have a name to add to their Christmas card list: BlackRock.
The world's largest asset manager has completed its sell-down of its two New Zealand holdings, Contact Energy and Meridian Energy, at market close on Friday last week. Hundreds of millions of dollars worth of stock changed hands.
The sell-down was prompted by a rebalancing of the component weightings of the index that it follows. It is perhaps easiest to explain this concept by way of example:
Previously, the fund (the iShares Global Clean Energy Fund) may have allocated 5% of funds under management to each of Contact and Meridian – in line with the underlying index that it chooses to follow. This may have equated to perhaps 60 million shares in Meridian and 40 million shares in Contact Energy – a figure that changes day to day as more money pours into the fund.
Anyone with any rudimentary knowledge of the New Zealand Stock Exchange would have been aware that such a transaction, if conducted carelessly, had potential to wildly shift markets. The New Zealand stock exchange does not have a high level of liquidity when compared to major overseas markets. Meridian Energy might typically trade a few million worth of stock each day, an amount that diminishes to a figure closer to nil over holiday periods. Simply put, very few New Zealanders are actively monitoring share prices on the 5th of January. The cricket, rightly, takes priority.
Contact and Meridian saw substantial price growth as the large new buyer purchased as many shares as it could find. The other stocks it invests in, such as Plug Power in the US, saw a similar effect. The fund performs well, gaining 20% in a week, prompting more interest and more money to pour in.
Eventually, it becomes apparent that a fund purporting to ''measure the performance of companies in global clean energy-related businesses from both developed and emerging markets'' should not have a tenth of its assets in two income stocks in a country of 5 million people.
Following a change to the underlying index, controlled by Standard and Poor's, and telegraphed publicly and well in advance, this 5% was reduced to less than 1%. With a stroke of a pen, BlackRock had too many shares in Contact and Meridian and must reduce its holdings. New Zealand investors are aware of this and react accordingly. The price falls.
Baffled New Zealanders, having sold the shares to a desperate BlackRock at $10 a share in January, were buying them back from a desperate BlackRock at $7.50 a share in April.
It would be tempting for investors in the ETF to believe that, somehow, New Zealand electricity stocks have hugely underperformed. It would be easy to decide that, through some mysterious catastrophic event, an operator of a decades-old hydroelectricity plant was worth 25% less after a 90-day period. Indeed, in all likelihood, the operators of the fund will justify this collapse in value due to ''index rebalancing'' or ''New Zealand underperformance''.
It was not. The root cause was two-fold:
The initial index construction was, fundamentally, flawed from the start. Meridian and Contact Energy are both well managed companies, profitable and operating within a sector that is defensive in nature. Investors in these stocks, typically, elect to invest for the semi-annual dividend income. Share price growth is possible, perhaps due to business efficiencies, population growth, underlying interest rate changes or changes in the price of electricity. However, neither is seeking to aggressively expand or corner a market. Those seeking to ride a wave of investment into green technology could find a more likely target for such investment elsewhere.
Secondly, as stated above, the way the trade was executed was almost doomed to fail.
Contact Energy had never – ever – reached $10. After trading for years between $4.50 on a bad day and $9 on a great day, the price was suddenly pushed close to $11. Meridian Energy saw exactly the same pattern, rocketing above $9 a share, well above any previous high. Existing buyers, sitting in the queue at $7 and $8 a share, shrugged their collective shoulders and waited. They did not have to wait long, with the price retreating towards normal levels within a week.
An actively managed fund would have certainly approached this differently. With more discretion available to them, such a fund manager would have been able to co-ordinate the investment through brokers, finding large sellers to minimise the on-market impact to the share price.
This is not to suggest Contact will never again reach these lofty heights. But realistically, the market price has settled again around $7, and in all likelihood, a return to $10 a share would prompt a significant amount of profit taking, limiting any potential gain. Time will tell.
BlackRock remains a large shareholder of the company, although its holdings in both energy companies have fallen below the 5% threshold that marks a holding as Substantial and requires heightened levels of disclosure. The share price should see reduced volatility, as the impact of this single buyer and seller will be less pronounced.
Ultimately, BlackRock (more precisely, the investors in this fund) has transferred hundreds of millions into the hands of New Zealand investors over the past three months, in what has turned out to be an expensive lesson for trading in comparatively illiquid markets.
_ _ _ _ _ _ _ _ _ _
Kevin will be in Timaru on April 27.
Edward will be in Auckland on April 29 (Albany) & April 30 (Remuera). He also plans to be in Auckland on June 10 & June 11, Napier on June 24 & June 25 and in Nelson in July.
Johnny will be in Christchurch on April 28 and again each month in May and June. He will be in Tauranga on May 12.
David will be in Kerikeri on May 6 and Whangarei on May 7.
If you would like to make an appointment, please contact our office.
Chris Lee & Partners Limited
This emailed client newsletter is confidential and is sent only to those clients who have requested it. In requesting it, you have accepted that it will not be reproduced in part, or in total, without the expressed permission of Chris Lee & Partners Ltd. The email, as a client newsletter, has some legal privileges because it is a client newsletter.
Any member of the media receiving this newsletter is agreeing to the specific terms of it, that is not to copy, publish or distribute these pages or the content of it, without permission from the copyright owner. This work is Copyright © 2021 by Chris Lee & Partners Ltd. To enquire about copyright clearances contact: firstname.lastname@example.org