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May 2015

As far as we can see

Winston Churchill said "it is always wise to look ahead, but difficult to look further than you can see".

Markets have been looking ahead for a long time now, and the second-guessing, predicting and forecasting has gathered pace recently because some in the market think they can see change coming and want to prepare accordingly.

The problem is, it is indeed difficult looking further than we can see, and our past experiences haven't offered much guidance either. The more we look ahead and fail to find any answers or clear signposts, the more we are inclined to retreat to safety until our vision improves. Hence the head scratching when the popular investment bets of the first three months turned upside down during April, and the sharp price reactions to those companies that fell short of earnings projections, and the handful of client phone calls asking whether it's time to change portfolios "just in case".

It's not as if markets have been entirely transparent and predictable – they never are – but you have to admit that things had been broadly tracking in the right direction so we had at least a degree of visibility. We knew that with interest rates remaining low and central banks intent on keeping economies growing, world share markets would be supported; as long as companies generated profits, then we would be rewarded through share price growth and increasing dividends. It hasn't felt risky or too much of a leap to assume that shares would continue to give us attractive returns. It has been pretty much a no-brainer to invest in the US since its economy has been improving by the month, whereas Europe clearly had a way to go.

But then a few things went awry last month; just enough to put the wind up investors.

Why did Europe suddenly become more popular than the US resulting in both European shares and currency beating their American counterparts in April? Why did the oil price soar 25% after declining 11% in the first three months of the year? Why did market darling Twitter, whose share price had rallied 40% in the first quarter, tumble 22% in April on revenue of $US436 million compared with the expected $US456 million? And why did yields of German government bonds bounce higher after approaching zero earlier in the month? These things didn't make sense and didn't align with what markets were expecting, so their immediate reaction was to retreat and wait for clearer signposts.

Maybe it was less about looking ahead and more about looking down.

You see, some markets and stocks had reached record high levels in April. The NASDAQ index set a new record after basically doing nothing for fifteen years since the tech boom and bust. Markets were already considered reasonably fully priced after the run we've enjoyed for several years. So maybe investors became fearful because they are afraid of heights? When you're up in the giddy heights it is easy to become well, giddy.

Carmel FisherBut while it is reasonable to feel scared if you are on a really tall ledge without a railing, it is less reasonable to fear a fall in financial markets from record highs. Markets are not subject to the laws of physics, and what goes up does not have to come right down again. Indeed if we are not careful, we could allow our fear or our desire to look further than we can actually see, destabilise our long term investment plans and make us miss our investment goals.

There were some odd things that happened during April, but fundamentals remain positive and there's no need to change our longer term expectations.

The view, as far as we can see, is still an attractive one.

Carmel Fisher
Managing Director | Fisher Funds

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Team Talk March 2015Team Talk

Sell in May and go away? Ashley Gardyne dispels this old investment saying.


Your KiwiSaver Portfolios

Highlights and Lowlights

  • Highlights and LowlightsIn New Zealand, Sky TV rallied during the month as investors recognised that the company has inherent strengths that other competitors cannot easily replicate. Summerset produced strong 1Q numbers for sales of both new and existing units at its retirement villages. Lastly, the EBOS share price weakened on the back of uncertainty over the Australian government's plans to cut costs in the pharmaceutical industry.
  • Across the Tasman, Flight Centre rallied on better than expected airline passenger volumes, while Tox Free Solutions was stronger on improving growth expectations.
  • First quarter reporting season has been positive for international portfolio stocks such as Google, eBay and Mastercard. However, our underweight position in China detracted from performance in May. The local Chinese share market is up over 50% over the last three months buoyed by more relaxed capital movement restrictions that has seen as many share accounts opened in China in the last three months as there were in 2012 and 2013 combined. Such speculative short term gains have to be viewed cautiously.
  • Global bond markets became more pessimistic as several prominent investors voiced concerns about return expectations.


Peer analysis

By Manuel Greenland, Senior Portfolio Manager, Australian Equities

Peer analysisPortfolio company Seek dominates the Australian online employment advertising market with 37 million visits to its site annually, and a leading 22% share of Australian job placements. LinkedIn, however, is the global leader in the space, with 364 million members in over 200 countries forming its network. We follow LinkedIn's strategies and performance to develop insights about our investment in Seek.

In April, LinkedIn announced its acquisition of Lynda.com, an online education company that helps users develop the skills needed to get jobs. Jeff Weiner, CEO of LinkedIn said both company missions were aligned in seeking to help professionals be better at what they do. Seek already has a profitable education division, and uses data collected from job adverts to customise its education courses. This helps job seekers to develop marketable skills, and recruiters to better fill vacancies. Seeing LinkedIn imitate Seek by marrying an education business to its job advert business adds to our confidence in Seek's strategy.

Seek's share price recently fell when it announced that short-term profits would be negatively impacted by the costs of developing a new Talent Search technology. Talent Search will allow recruiters to search a database of candidate CV's to identify and reach all people who may suit a job vacancy, instead of only reaching people who view and respond to a job advert. We analysed LinkedIn's sales strategy to evaluate the wisdom of Seek's decision. In addition to selling job ads, LinkedIn also has a Talent Solutions business, which similarly allows recruiters to search a library of candidate CV's to reach all people who may suit available jobs. Critically, LinkedIn generates 2.6x more revenue in its Talent Solutions business than it does from selling job ads. We quickly recognised that Seek's decision to invest in this technology could pay off handsomely in long-term growth, and we took the opportunity to buy into the company.

We invest in those businesses whose strengths are likely to see them larger and more successful over the medium term. Thoughtfully comparing the companies we own with their peers can deliver valuable insights and give us even more confidence when they are on the right track!


Is this the beginning of the end?

By David McLeish, Senior Portfolio Manager, Fixed Interest

Is this the beginning of the end?Many commentators (ourselves included) have been cooling on the bull market in bonds for some years now. Just to be clear, a bond bull market is when interest rates, or the yields on fixed interest investments, fall. As yields fall, the value of bonds goes up. As any investor with fixed interest investments will know, there has been lots of money made out of bonds over many years as interest rates have continued to fall – some even falling into negative territory (where investors pay for the privilege of having their money in "safe" bonds!). Bonds tend to perform best in negative conditions, such as when there is recession or deflation.

The bond bull market has continued even as the business cycle has ebbed and flowed, hence some of us suggesting that bonds are overvalued. Perhaps it has made sense for yields to continue to fall in Europe, because the Europeans are taking the longest to emerge from recessionary conditions; but the strong bond market in other countries hasn't been as easy to understand.

In the last week of April, it looked like the turning point might have arrived. First off, there was a pronounced rise in German bund yields. This led to other global bond yields also rising. Then there were some pronouncements from well-known bond experts saying that this was the beginning of the end. It even flowed through to Australian banking stocks, whose shares pay attractive dividends, and have benefited strongly from low bond yields. They fell some 5% in just two days.

Whether or not this is a turning point, investors should prepare themselves for less attractive returns than they have been used to. For bonds, the ideal (negative) economic conditions for them are not as prevalent right now and central banks are unlikely to be as quick to underwrite them as they have in the past. That is not to say that the bond market will "crash". As one commentator said this week, bond bull markets tend to end gradually, and then suddenly. Last week might well have been the suddenly.


Too Few Eggs

By Murray Brown, Senior Portfolio Manager, New Zealand Equities

Too Few EggsThe recent resignation of Sir Ron Brierley from the Coats Group Plc Board (formerly known as Guinness Peat Group or GPG) brings an end to an era following his 25 years as a director of the company; 20 years as Chairman. Sir Ron previously had a 30-year stint at Brierley Investments, a company he founded in the early 1960's.

Both Brierley Investments and Guinness Peat Group were highly successful companies in the early part of their lives. Each then made one single large investment that dramatically changed the course of the respective companies, to the ongoing detriment of shareholder value. This brings into question the wisdom of having too few eggs in the basket, a classic investor mistake.

Brierley Investments (now known as Guocoleisure and no longer listed on the NZX) made a large investment in a hotel chain called Thistle Hotels that represented over half of its assets at that time. The acquisition was made with debt, just prior to the share market crash of 1987. The acquisition was the company's undoing. It had to sell off virtually all of its other liquid investments to avoid going under. Once New Zealand's largest company, it is now a shadow of its former self.

In the case of GPG, the company invested heavily into Coats Group, the world's largest thread maker. Again, Coats Group represented around half of GPG's assets at the time of the GFC. This time, the problem was different. GPG had no debt, in fact it had considerable cash reserves. Shareholder activism forced changes to the board, and a change in strategy – sell off all the investments, focus on Coats Group and pay out the excess cash. Unfortunately, the strategy hadn't factored in that the UK Pensions Regulator has a different view on the company's ability to pay out the cash, and this remains the subject of a longstanding and unresolved investigation. Although Coats Group remains a sound company, its share price is still less than half what it was prior to the GFC.

Two related companies, with a common problem – too few eggs in the basket, with the big ones stifling the smaller ones.


What we're reading ...

What we’re reading ...This month's interesting read again came from within our own office, with Director Frank Jasper sharing correspondence with a client, Richard, around social and ethical investing.

Richard: I am interested to know what steps your company is taking to divest itself from the fossil fuel industry. You may be aware there is a global movement to divest from this industry which is a key contributor to the continuing escalation of the concentration of atmospheric CO2 driving climate change. I would appreciate knowing how your investment policies align with this strategy.

Frank: As you may appreciate this is a very complex area for us given that we manage the retirement savings of over 250,000 New Zealanders who have diverse views on a range of social, ethical and political issues. The approach we take to these issues will not please everyone all of the time. We have to acknowledge that and find a way forward that fulfils our broad sense of mission as a business and one reflects the diverse views across our client base.

Our approach to date has been to avoid those areas that prove to be repugnant to a majority of our clients but to otherwise avoid making less clear ethical judgements. Allied with this we seek to invest in businesses we regard as commercially sustainable and that will generate attractive long term returns for our investors. What does mean in practice?

  1. We systematically avoid any investment in tobacco and arms manufacturing businesses. This is a blanket rule across all of our investment strategies. It can prove challenging to define exactly which companies to screen out in the arms manufacture business given the long supply chain to this industry, but we focus on those end of chain manufacturers generating a majority of their revenues from the supply of arms.
  2. In our company research processes we focus on sustainability from an economic perspective. By definition this includes cognisance of the social environment in which business operates. This is important given that socially unacceptable practices, for instance employment of child labour, may negatively influence the long run franchise of a business and prove to be a poor investment. To be clear, though, this is not an ethical judgement rather a judgement about what drives the long term profit outlook for a business.
  3. This leads on to a discussion on the "fossil fuels" business. At this stage we do not preclude investments to this sector. Our judgement call, at least for now, is that the weight of our clients, whilst concerned about the long run impact of fossil fuels on man-made climate change, are still comfortable investing in this sector. Similarly, while acknowledging there is some long run risk to the outlook for energy businesses, this risk is still sufficiently far away that they still represent an appropriate investment destination from an economic return perspective.

I hope you understand the necessary juggling act that we face in building portfolios that generate attractive long term returns in a way that meets the expectations of our clients.


Getting to know ... Subordinated debt

Getting to know ... Subordinated debt The definition of subordinate is someone or something that is treated or regarded as of lesser importance than someone or something else. And so it is with subordinated notes or subordinated debt, which are fixed interest investments that rank lower than other debts if the issuer falls into liquidation or bankruptcy.

In the current environment where investors are hungry for yield, subordinated notes can be attractive compared to higher-ranking debt so it's no surprise to see more of these being issued. There can be fish hooks to look out for though so here's what you need to know.

Because subordinated debts are repayable after other debts have been paid, they are more risky for the investor or lender of the money. Subordinated loans typically have a lower credit rating than senior debt, so they must offer a higher yield to compensate lenders for the higher risk.

Subordinated debt may be secured or unsecured, and in the event of the anything negative happening to the issuer, you may be last in line for payment. So choose the issuer carefully. The other negative is that except in limited circumstances, investors can't get their money back by redeeming the debt. Often subordinated notes do not have a maturity date and the issuer has the option to redeem when it suits them. Issuers can also have quite a lot of flexibility to change the terms to suit, and in some instances, your debt can be converted to a completely different security like a share, with a completely different risk profile altogether.

Successful investing involves being properly compensated for the risks taken. With subordinated debt, make sure you are receiving sufficient compensation (ie. a high enough yield) for the risks you are accepting.


Managing your KiwiSaver account

Who doesn't love free stuff?

Who doesn't love free stuff?It's now less than two months until the end of the KiwiSaver year so it's a good time to see if you are on track to make sure you get your annual government contribution of $521.

As a reminder, for every $1 you contribute to your KiwiSaver account you'll receive 50 cents from the government, up to a maximum of $521.43 - this generous KiwiSaver incentive is known as the member tax credit (MTC). Now that's free stuff worth having!

To maximise your full MTC entitlement of $521.43 you need to have contributed at least $1,042.86 (the equivalent of $20 per week) into your KiwiSaver account.  If you have not put in at least this amount, you can top up your KiwiSaver account for the current KiwiSaver year but make sure you do it by Friday 26 June 2015.

You can read more online about who is eligible for a MTC, how it is calculated and how to make a payment.


Mail from Fisher Funds

Mail from Fisher FundsIn the second half of May we'll be sending you your member statement and annual PIE tax statement for the financial year ended 31 March 2015. Keep an eye out on your email inbox or letterbox.

As a reminder, the Fisher Funds TWO KiwiSaver Scheme is a Portfolio Investment Entity and has paid or claimed tax on your behalf for the year to 31 March 2015. If you had a tax liability we have sold units in your KiwiSaver account to that dollar value to pay that liability to IRD. Likewise, if you were entitled to a refund, we purchased units to that dollar value in the relevant fund/s.

Please note you do not need to include this income in your personal tax return (if you complete one) unless you had tax deducted at a rate that was lower than it should have been.

The back page of your annual PIE tax statement contains answers to some commonly asked tax questions which you may find useful.

You can read more about the PIE tax regime online.


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