Bad parenting from central banks
Any investor who enjoys the thrill of finding an overlooked, undervalued gem has had a miserable time of late. Markets haven't been about individual gems. The focus is back on central bank policy, with the will-they-won't-they speculation resulting in increased volatility in both bond and stock markets.
As we know, unconventional central bank monetary policies have underpinned markets for some years. We have enjoyed a period of relative calm since the wobbles around the Brexit vote in June.
Recently though there has been increasing concern about the longer term impact of central banks' involvement in financial markets, and in particular, what happens when they realise that ever lower interest rates aren't working to stimulate economic growth.
One commentator described a 'distinctly mixed feeling' in markets during September with 'more stick than carrot, more push than pull and more frustration than joy'.
We should prepare for more mixed markets and more volatility in coming months, particularly when the US election tension is thrown into the mix.
A columnist's recent description of the 'parenting approach' of central banks helped put their influence on market behaviour into perspective.
In Miller's Market Musings, Jeffrey Miller discussed what a parent's goal might be. One answer might be to provide guidance and life lessons so that your children become good people. A near term goal might be for them to be safe, or healthy or happy.
But you probably wouldn't answer 'my goal is for my children to always be happy, to never experience pain, or sadness or disappointment. To always get what they want, and to never hear the word No.'
That sort of parent spoils their kids and you know they're probably going to turn out badly.
Yet central bankers around the world are those parents. The ones you don't let your kids play with. Those spoiled kids take greater risks and do dumber things because there are never any consequences for their actions.
Miller says the Federal Reserve is encouraging people to do riskier things because they fear upsetting them with a few interest rate hikes and a fall in asset prices. They want markets to be happy and hope that happy markets will translate into a happy and growing economy.
But the bad parents at the Federal Reserve don't realise that if they take away someone's 'safe' income (by lowering interest rates) they aren't going to have any money to spend; and forcing them to buy yield producing but-not-100%-safe assets is not going to make them comfortable enough to spend.
Miller suggests the Fed should have raised rates a while ago and markets would have ultimately got used to the idea, just like children get used to hearing the occasional 'No'.
Continuing his parenting theme, Miller discussed college homecoming parties, saying 'at some point, most people realise they should leave a party.' Some have been taught to leave early, when people start to get drunk and obnoxious. Some leave only when they are drunk and obnoxious. Others don't leave until the cops show up — they're the ones who get arrested.
'Don't be an idiot. Protect your portfolio. Don't stay at the party thinking you can leave before the cops show up. They always show up eventually.'
I agree with Miller that investors who assume central banks will keep supporting markets are in for a rude awakening. Some assets have become expensive, some investors have overlooked the riskiness of assets, and some have not positioned their portfolios for a quick getaway!
We're taking care of your portfolios to ensure we don't overpay, we are mindful of risk, and we are well positioned whatever central banks do from here. But we should be prepared for a rowdy few months – not everyone has the same parenting skills!
Managing Director | Fisher Funds
Highlights and Lowlights
This month we share how each investment portfolio is tracking, including some of the highs and lows direct from our investment team.
Farewell Murray Brown
We are sad to farewell Murray this month after an exemplary eight years at the helm of our New Zealand share portfolios and our Property & Infrastructure Fund. Murray has decided to retire and change his focus from managing a portfolio of shares to managing a portfolio of leisure and other interests! We wish him the very best and will introduce Murray's successor in due course.
It was relatively quiet on the news-front in New Zealand during September, although the New Zealand portfolio managed to produce a positive return in a market that fell 0.5%. Restaurant Brands recorded solid second quarter sales, with KFC, Starbucks and Pizza Hut all recording positive same store sales growth. The Tegel share price fell during the month as its major competitor Inghams looked to list in Australia. There was some selling of Tegel shares as investors looked to fund a potential investment in its competitor, and lower poultry prices in domestic supermarkets have put pressure on Tegel's earnings.
September saw a continued rally in mining stocks on stronger commodity prices, and continued weak demand for shares of companies offering reliable earnings and cash flows, making for a challenging performance environment for our Australian portfolio. Nanosonics was up on strong sales growth prospects, Credit Corp responded well to a maturing of its Aussie consumer lending business and Ooh Media and APN Outdoor rebounded from oversold positions. Shares of Vocus were weak as the shares of a peer communications company, TPG Telecom, fell following a poor earnings outlook.
The International portfolio outperformed its benchmark last month mainly due to stock selection in North America. US Markets were up for September, with the electronic technology sector performing well, however one of the worst performers came from the finance sector with Wells Fargo down 11.98%. The top contributors this month were Apple Inc. up 6.18%, BHP Billiton Plc up 16.72% and Amazon.com up 8.92%.
Emerging markets once again outperformed developed economies, up by 1.54% in September. Electronic technology, retail trade and technology services all had strong returns for the month in the Pacific Rim region, which had the highest returns for the month. Our external manager's investment in SK Hynix Inc (a Korean semiconductor producer) was the largest contributor to its outperformance against the benchmark for the month, up 35.9% YTD.
Investors came back from their Northern hemisphere summer break straight into a round of central bank meetings that had the potential to alter trends in interest rate markets. Most of the focus was on meetings in the United States and Japan. In the US the Federal Reserve continues to prepare investors for rising short term interest rates, probably sometime this year. In Japan there had been speculation that the Bank of Japan could be aggressive in cutting already negative interest rates. This did not happen. The Bank instead, pledged to hold ten year yields near zero and abandoned its target for expanding the monetary base.
Despite the volatility that led into these announcements fixed income holdings were largely unmoved over the month. With equities mirroring the volatility in interest rates this put a little upward pressure on credit spreads which widened in the US and Europe over the month.
Your KiwiSaver portfolios
Beware Government funding in the retirement village sector
By Murray Brown, Senior Portfolio Manager, New Zealand
We like the New Zealand retirement village sector, having been a shareholder in Ryman Healthcare for over a decade, and in Summerset since it listed in 2011. Both have been outstanding performers for our New Zealand portfolio over an extended period. There is much to like about their business models, in particular their 'continuum of care' strategy of caring for their residents as they age within their villages. The level of Government funding in Ryman and Summerset's business models are modest, and are largely restricted to the small aged care part of the village.
Contrast this to the Australian listed retirement village sector, where Australian Federal Government funding is the key driver of their business models. The listed operators Estia Health, Japara Healthcare and Regis Healthcare operate solely in the aged care end of the market, typically buy rather than build their villages and rely heavily on Government funding to operate their villages. Their funding is by way of Aged Care Funding Instruments (ACFI), with the Federal Government providing accommodation bond deposits and daily care funding for the elderly in retirement villages.
The trouble with relying on Government funding is that healthcare budgets are always under pressure, particularly as the population ages. If budgets get cut, earnings and share prices of the aged care operators can come under pressure. This is exactly what we've seen over the last two months.
The Federal Government indicated it will tighten ACFI funding in August, which has seen analysts' reduce their earnings forecasts for the three Australian listed aged care operators by ~20%, and the share prices weaken by up to 35%. Regis Healthcare builds many of its own villages and has been the least affected by the funding costs of the listed Australian operators.
Should we be concerned that Ryman Healthcare is looking to expand into the Melbourne market? No, we believe that its superior model and development margins will ensure that government funding will remain an immaterial part of its business model as it expands into that new marketplace.
Green light for Auckland congestion charges
By Ashley Gardyne, Portfolio Manager, Property & Infrastructure
Auckland's transport woes are again in the spotlight as local body elections kick into top gear. While traffic is a never ending frustration for many Aucklanders, those living outside of Auckland probably feel equally frustrated that their tax dollars are being funneled towards Auckland's road and rail projects in ever increasing quantities.
But perhaps a solution is in sight. During September the New Zealand Government hinted it was considering congestion charges for Auckland. The impact of these charges (particularly if higher at peak times) would be to reduce vehicle numbers and improve the flow of traffic — a win for Aucklanders currently facing long commutes. By levying those using the most congested routes, charges are borne by those who benefit from faster flowing traffic, rather than taxpayers at large.
The introduction of a congestion charge in London in 2003 was highly successful in reducing traffic in the city and increasing the use of public transport. In fact, by 2006 there were 21% fewer vehicles on the roads despite a massive increase in buses (+25%), taxis (+13%) and bikes (+49%).
Toll roads currently account for less than 2% of roads in most developed countries. However, this number is starting to increase given significant Government debt burdens and a preference by taxpayers in many countries for user-pays models.
While congestion charges are a particularly contentious topic in Auckland, the increasing prevalence of toll road concessions creates an investment opportunity for infrastructure investors globally.
Toll road operators have many of the qualities we seek in an investment. Not only do they have stable cash flows and attractive dividend yields, but increasing Government acceptance of private sector infrastructure delivery provides attractive long term growth opportunities. For a well-run operator like Transurban Group (Australia) who we're invested in, the road ahead looks clear!
Some risks are better than others
By David McLeish, Senior Portfolio Manager, Fixed Interest
We all know that investing involves taking calculated risks.
There is, rightly, a lot of emphasis placed on ensuring that in pursuing their investment goals; investors not only understand the risks associated with their investments but that they find those risks acceptable.
In today's low deposit rate world, it can be tempting to straddle the extreme ends of the risk spectrum, combining cash at one end as the 'safe bet' and shares at the other to give higher returns, albeit with higher risk. This strategy can however put your long term investment goals in jeopardy.
It is important to understand the full range of investment options available to you.
While most understand the characteristics of term deposits and shares, less is known about fixed income investments that typically sit in between these two on the risk spectrum. It is here that we can find investments that may prove interesting in the current environment.
Independent research conducted by global asset managers, Alliance Bernstein and Wellington Asset Management, showed that investing in high-quality, low-duration bonds might be the 'Goldilocks' investment for those wanting to take a more considered approach to investing.
Why are these assets so interesting right now?
A lot has to do with duration, a measure of a bond's sensitivity to changes in interest rates. In general, when interest rates rise, bond prices fall. By choosing bonds that have less chance of materially falling in value should interest rates rise, the income they generate can be more easily relied on.
As for the high-quality aspect, that has more to do with where we are in the economic cycle. If we are in the late stages of this current expansion, as the two managers suspect, reaching for higher returns from lower quality bonds could prove dangerous, as company defaults may rise.
How investors choose to balance risk and return will of course vary depending on individual needs and comfort levels. But in today's volatile markets, it pays to be aware of all of your investment options.
US election through Aussie eyes
By Manuel Greenland, Senior Portfolio Manager, Australia
Should Australian investors care that the Mexican peso weakened significantly versus the US dollar over September? The short answer is yes, because Mexico's currency weakens as Donald Trump's chance of winning the upcoming US election improves. So this one currency exchange rate reflects the probability of a Trump win, which is relevant for all investors.
Trump's weakness and greatest strength are one in the same; he is the candidate from outside the political establishment. If he wins, the ensuing uncertainty is likely to drive immediate weakness in financial markets. Both Australian shares and the Australian dollar are likely to prove among the more vulnerable of developed market financial assets to a short term sell off.
The medium term impact on Australia is likely to be more muted. Trump has promised to protect the US from cheap imports, but Australia exports relatively little to the United States. Australia produces key raw materials at the most globally competitive prices, so anyone wanting to manufacture finished goods would probably need to buy materials from Australia. Trump has indicated he would spend more to drive growth, so demand for Australian commodities could well enjoy an unexpected boost, as could sales of Aussie companies operating in the US construction market like Reliance Worldwide.
Trump has also promised to repeal Obama's Healthcare reform, which in improving healthcare access generally drove up sales volumes and lowered prices. Some Australian companies like Sonic Healthcare have benefited from increased volumes on wider healthcare access, while others like CSL have suffered from greater levels of regulated pricing. So the impact for Australia would likely be mixed.
While the outcome of the race for the world's top political job grabs headlines, and will probably drive some short term market volatility, the medium term effects for Australia appear less dramatic; except perhaps for anyone hoping to immigrate to the US should its border close!
The GFC still lingers, at least for Germany's largest Bank
By Mark Brighouse, Chief Investment Officer
Two things were of interest this month and they were strongly interconnected. The first was Deutsche Bank's share price decline to the lowest levels in 30 years and the second was foreign exchange trader Kevin Rodger's account of his three decade career in financial markets.
Much of Mr Rodgers book is about his time at Deutsche Bank and the transformation of the firm which had a 3% market share in global foreign exchange in 1995 and became the world's largest with a 22% market share in 2008. This push into investment banking, along with a tailwind of demand for all kinds of derivative securities, drove the bank's share price to nearly 120 euros before the global financial crisis hit.
With the share price tumbling to around ten euros this month, people are asking 'what went wrong at this former behemoth?'
Much of it stems from the fallout from the US mortgage market that snowballed into the global financial crisis (GFC). Deutsche Bank has been hit with heavy penalties from the US Department of Justice for miss-selling mortgage securities. Some commentators doubt the bank can afford to pay the potential civil claims that could result. Also, the bank's interest rate traders were found to have colluded with others to manipulate the so-called London Interbank Offered Rate benchmarks that influence the rates of vast amounts of loans. In recent times, the low levels of interest rates in Europe have limited the bank's ability to earn a decent return on its assets and rebuild its profitability.
So here we are, almost ten years after the GFC, and even though many people have seen their share portfolios and property prices recover strongly since 2007 there are still parts of the world where the effects of the GFC are continuing to exert a big and lasting influence.
An upside-down world
By David McLeish, Senior Portfolio Manager, Fixed Interest
The thought of buying bonds for a capital gain and shares for their yield would seem quite strange to most (the author included). But in a world of low and sometimes negative bond yields, this is exactly what has been driving investment flows of late.
Bonds have churned out another year of solid returns, outstripping share market returns in many cases. But what's far more remarkable is that over 80% of the returns generated by US, UK and German Government bonds have come from gains in their price (i.e. capital gains). No longer are bondholders the patient income-seeking bunch they used to be.
Low bond yields are proving to be a rather persistent phenomenon. The benchmark ten-year German government bond for example has now spent the last two years offering investors less than a 1% yield. It's this persistence that has caused many to rethink their investment strategy — looking instead to shares as a source of higher income.
The hunt for yield as many call it is a very real and powerful market dynamic that's expected to grow stronger over time. The world's population is ageing and as people near retirement they typically seek to replace, or at least supplement their work income with investment income.
Shares offer income through the distribution of dividends, and on the surface the income they offer does indeed look attractive. However, this is neither certain (management can stop paying dividends at any time) nor is it without risk (share prices have historically been more than twice as volatile as bond prices).
To some, the upside-down strategy where bonds and shares play quite different roles than typically expected may seem like a logical response to a changing investment environment. But this line of thinking deserves a word of caution. History suggests that when asset classes become overrun with non-traditional investors (who are typically there for a good time not a long time) volatility ensues. There is no reason to expect anything different this time.
Managing your KiwiSaver account
KiwiSaver and local body elections: more similar than you realise
You can't turn on your TV, read the paper or go for a drive without someone pitching for your vote in this year's local body elections. But what does this have to do with KiwiSaver? Quite a bit actually!
Over half of New Zealanders don't bother voting in local body elections despite all the marketing and election promises. Yet we care deeply about how our local Council will improve our roads, remove our rubbish and ensure we have clean water. We pay a lot of attention to how our rates are rising and how the council spends our rate money, yet we care relatively less about who the councilors are who will be spending our money and determining our rates!
There are lots of similarities with KiwiSaver. We all want to see our savings grow, so we can enjoy the retirement lifestyle we want or buy our first home. However, many New Zealanders don't take enough notice of what's happening with their KiwiSaver account. While we certainly care about how much of a nest egg we'll have in the future and that we'll have enough when the time comes, we don't take the time now to ensure we're making the best decisions to benefit our future.
Shortly, you'll be receiving your six monthly KiwiSaver account summary. It contains lots of useful information about your KiwiSaver account including your current balance and what fund or funds you're invested in. Just as in local body elections, you do have a choice! We encourage you to check out your account summary and make sure you're happy with how your nest egg is growing. We are happy for you to contact us if you have any questions about it, or just want to make sure you're making the most of your KiwiSaver account.
So what should you be looking for?
- The power of KiwiSaver — the summary statement on page one demonstrates how the combination of your contributions and those from the Government and your employer (if applicable) really makes a difference. Make sure you're maximizing all of these.
- How have your savings grown? Markets can go up and down, but your account will have tracked well over the long term. The graph at the top of page two shows the growth in your balance since you joined Fisher Funds. If they're not growing fast enough for your liking, perhaps you need to consider if you are in the right fund or combination of funds.
- How is your money invested? The mix of funds your money is invested in has a big impact on the growth of your savings. If you haven't reviewed this for a while or ever, talk to your adviser or take our simple questionnaire.
- Are you on the right tax rate? You wouldn't pay more rates than you had to; make sure you're not paying more tax on your KiwiSaver account than you need to.
- Where is your money invested? See where in the world and in what type of assets your money is invested, plus the top ten investments. It is important that you have at least a broad understanding of how your savings are invested.
- Track your account online — see your balance and transactions online at any time, update personal details and keep track of how your nest egg is growing.