Debt up to our ears
My generation loves to remind today's younger generations that first mortgage rates were near 20% in the mid-1980's. This fact is often recalled within a statement of either "toughen up" or "be careful it could happen again", directed at today's younger generations buying exorbitantly priced houses. That though was over 30 years ago and the world has changed immeasurably since then. However, only 10 years ago the RBNZ Overnight Cash Rate (OCR) was 8.25%; today it is 1.75% and it has been at that level since November 2016. Having experienced very high interest rates in such recent history does dominate many investors thinking. This tends to create undue caution to their investment decisions today or creates undue expectations of what represents fair and sustainable medium term returns. So many investors are caught up in this old paradigm.
At the most recent RBNZ OCR review, Governor Orr signed off by saying that they would ensure the OCR is at the current expansionary level for a considerable period. That is, a sub 2% OCR is here for the foreseeable future unless something materially changes, which is not currently on the RBNZ radar.
Low interest rates are here to stay
So why are interest rates likely to stay so very low for an extended period, and why should we put aside such recent history? The answer is the world is awash with debt. To offset the depressing effect of the GFC, governments and households have taken on mountains of debt to maintain employment, sustain incomes and to take advantage of the very low interest rates to buy assets, particularly property. In New Zealand household debt was $14b in 1985, $135b in 2008 and $211b today. Increases in interest rates today, would apply to a far greater pool of household debt, and therefore affect consumer spending in a far greater way than it would have in earlier years. This significantly increases the power of the RBNZ (through the level of interest rates) to impact the wider economy. It also suggests that even modest lifts in interest rates could cripple many households, reducing the chances that this will be allowed to occur.
The situation is no better in many other western nations. In Australia for example, household debt in 2008 was $1.1 trillion whereas it is $2.5 trillion today. The Australian economy is now in effect held hostage by the mortgage market.
Shares will remain attractive to investors
It is very difficult for many of us to get high-interest rates out of our investing mindset. Yet when the level of global debt is analysed, it really does suggest that the upside risk to interest rates is limited, relative to our recent memories. That also suggests that we all have to re-engineer our businesses and lifestyle for this new paradigm. It also means that shares will ultimately remain a core part of investors portfolios long into retirement. Living entirely off interest from term deposits and government bonds is a strategy most likely destined for the distant memory just like 20% mortgage rates. You can all thank households' appetite for ever increasing mortgages for that.
Chief Executive | Fisher Funds
3-Step KiwiSaver health check
By Fisher Funds
You will have received your KiwiSaver annual statement recently, and with a whole year's worth of activity at your fingertips it's a great opportunity to check your KiwiSaver account. Take a few minutes to make sure you're maximising your savings potential wherever possible.
We recommend zeroing in on the following three points to assess whether you're getting the most out of your saving.
Am I in the right fund?
KiwiSaver funds fall into four categories:
It's crucial to ensure you're investing in the right investment strategy based on your age, life stage and comfort level with risk. For example, the fund you initially invested in might not be right for you anymore, particularly if your financial situation has changed, or you've gone through a major life change, such as getting a mortgage. Switching to a different fund now could help you to achieve your goals faster.
At Fisher Funds, we offer Conservative, Balanced and Growth Funds, with a GlidePath option which auto-selects the appropriate fund based on your age and investment timeframe over the course of your life. Think of GlidePath as a set and forget strategy.
In general, lower-risk funds like Defensive and Conservative funds carry lower fees and are lower risk. But this can also mean you don't see returns as high as those in higher-risk funds. Balanced and Growth funds will generally provide you with higher returns over a longer term, but come with a higher level of risk, which you have to be comfortable with.
Not sure what fund is right for you?
If you're unsure which type of fund is right for you, take our questionnaire to help determine the right investment strategy for you.
When selecting your investment strategy, ask yourself these questions:
- What are my priorities? Long term growth or short term savings?
- How comfortable am I seeing my KiwiSaver balance go up and down?
- When do I plan on spending my KiwiSaver money?
Am I paying too much tax?
Did you know that the PIE tax statement for your KiwiSaver statement could be telling you that you're paying too much tax? Your KiwiSaver Provider calculates and pays the tax you are liable for on your behalf, and you are placed in a tax bracket based on your income. But are you in the right bracket?
Checking your tax rate
The PIR (Prescribed Investor Rate) on your KiwiSaver statement determines how much tax you pay on your investment. If you're on the wrong rate, you could be paying more than you need to in tax each year! You can see where to check your PIR rate on your statement here.
How your tax rate is calculated
Have I been paid my Member Tax Credit (MTC)?
MTC's for the KiwiSaver year ending 30 June 2018 will be applied to your account by the end of July 2018.
If you contributed $1,042.86 to your KiwiSaver between 1 July 2016 and 30 June 2017 (and were between the ages of 18 and 65 for the 12 months of that same period) you should see a payment of $521.43 from the government sometime in July or August 2017 on your KiwiSaver annual statement. No strings attached! This is called the Member Tax Credit (MTC), which is the government's way of rewarding you for contributing to your retirement savings each year.
If you contributed less than $1,042.86, you'll see a smaller tax credit payment based on the amount that you contributed (calculated at 50 cents for every dollar, up to the maximum of $521.43).
If you missed out last year this is a great reminder to get your contributions set up so you get the full $521.43 every year.
If you're receiving a salary or wages
If you're between the ages of 18 and 65, earning more than $35,000 per annum and contributing at least 3% of each pay cheque to KiwiSaver, you'll have no problem reaching the maximum contribution and getting the full tax credit.
If you're self-employed or not working
Remember you can qualify for the MTC too! It's a good idea to either make a few one-off payments or set up a direct debit of $20 per week so that, over the course of the year, you contribute the full $1,042.86.
Log onto the Fisher Funds online portal now to make a one-off payment, set up a regular direct debit payment, or download a form to change your employee contribution rate to ensure that you'll get the full tax credit next year.
How healthy is your KiwiSaver Account?
Based on this quick three-step health check, how healthy is your KiwiSaver account? If you would like to discuss any element of your statement this year, get in touch — we are happy to help you optimise your savings.
Your KiwiSaver portfolios: Highlights and lowlights
It was again a strong month for the New Zealand portfolio, rising 4.3% and comfortably outperforming the S&P/NZX50G index which was up +3.3%.
Fisher & Paykel Healthcare, Xero and Vista Group were the Fund's top performers on little news flow, and drove a meaningful share of both absolute return and the majority of our outperformance relative to the index. There were no material detractors during the month, but we were surprised with the announcement from Michael Hill that it will immediately close all six remaining Emma & Roe stores, rather than undergoing the trial phase announced in March.
In July the Australian portfolio returned 3.3% trailing the benchmark ASX 200 which was up 3.7% for the month. Our performance was relatively broad based with the healthcare and commercial sectors leading the way. Top performer was Nanosonics, gaining 19% for the month off the back of news of regulatory approvals in some key international markets for their second generation Trophon. Double digit growth was also achieved by Insignia (+15%), APN Outdoor (+10%) and Wisetech Global (+17%). The biggest drag on performance was Ramsay Healthcare, down 12% for the month after being plagued by revenue headwinds.
The International Equity Fund returned 3% during the month of June and performed in line with its benchmark. Global markets grappled with rising trade tensions and this will remain a key theme given the potential for these actions to hurt business confidence, raise inflation and ultimately disrupt the calm growth environment we have been experiencing since the Financial Crisis. The consumer staples sector led the market, followed by utility and healthcare stocks. In a mid-month break, Technology stocks fell from grace and posted negative gains for the period alongside the industrials and financials sectors. The top contributors to benchmark-relative returns included media company Twenty-First Century Fox which spiked 33% as Disney received approval from the US Government to acquire the firm. The fund also owns Disney which rose 9.2% over the month. Top detractors included Caterpillar down 10% after reporting falling growth in its sales. Lower exposures than the benchmark to Amazon, Alphabet (the parent company of Google) and Netflix also detracted from performance as all three firms had another good month. The depreciation of the New Zealand Dollar versus other major currencies resulted in a two year low being reached against the US Dollar in which we saw a 3% depreciation. As foreign assets are now more valuable when converted into the home currency, portfolio returns were significantly boosted in NZ Dollar terms.
All fixed income portfolios contributed positively to this month's outperformance over the benchmark. An unusually wide range of positions contributed to this, as each manager currently holds quite divergent views on where value in the global fixed income markets lies. One of the key contributors however was the strong performance our international managers achieved from their holdings in key securitized assets.
Our international managers remain overweight corporate credit risk at this juncture and it was the underperformance of this asset class this month that dragged back performance most. Fund-wide exposure to credit has been reduced recently via one of our managers however it remains a key overweight for now.
Your KiwiSaver portfolios
Last month I was in Wellington where I had the chance to meet with some clients. As I am originally from the Hutt Valley I can say this; Wellington was on its very best Wellington behaviour. It was tempestuous, with that special horizontal rain that I am convinced blows straight in from Antarctica and has a gift for finding a way down the neck of your jacket and then chills you to the bone.
One of the things I covered in my presentation was the idea that building long-term wealth requires a little bravery — being brave enough to take positions that feel a little uncomfortable at the time or that may even seem counterintuitive. Ultimately, though, swimming against the popular tide has on many occasions resulted in our best long-term successes.
While the environment for one of the Australian companies in our portfolio Brambles, hasn't been quite as tempestuous as a Wellington southerly, it has been difficult. On this occasion though we think the storm has delivered us the opportunity to increase our investment at a very reasonable price. While it takes a little bravery to add to an investment when the news on the company isn't exactly great, this is precisely the right time to do it, given our belief that Brambles is a high quality company with sound long-term growth prospects.
Brambles is the leading global supplier of pooled pallet and reusable crate solutions to its customers, primarily in the fast moving consumer goods sector. The company has a long history of generating shareholder wealth and a track record of making smart strategic decisions.
At the moment, Brambles is facing transport and plant cost pressures in its key US pallets market. The list of challenges is long; higher fuel prices, driver shortages, some changes in customer behaviour in response to higher transport costs, higher lumber costs, inefficiencies due to capacity constraints, and changes in commercial relations with some retailers. These headwinds have pressured Brambles' profit margins in the US.
The company is working to relieve these pressures by implementing surcharges and adjusting contract terms as contracts roll over. It is also investing in a plant automation programme that will modernise its US service centre network to a standard similar to its more efficient European network. While these initiatives all make sense to us, these actions with the exception of surcharges, are not a short-term fix and we expect pressure to still be evident on the company's near-term earnings.
Brambles' balance sheet pressures are currently being reflected in its share price, and the valuation of the company, based on metrics like the price to earnings ratio, is sitting at five year lows. We believe this is the opportunity. Brambles is growing its revenues in mid-single digit levels, and we believe the company will continue to keep growing at such rates for years to come. As Brambles solves its short-term cost challenges, margins should improve turning forecast revenue growth into even healthier profit growth.
We love buying shares in high quality, growing companies on sale and have added to our investment in Brambles. We believe now is the time to be patient, ride out the storm and enjoy the good weather to come. We all know you can't beat Wellington on a good day. Fingers crossed out increased investment in Brambles gives us that same warm feeling.
One of my favourite past times while at Otago University was heading down to the House of Taine (or Pain depending on your vintage) to watch the rugby. Jerseys were loose, rugby was played under the winter sun and both seats and terraces were packed to the rafters with supporters. Watching the Auckland Blues the other day, I was struck by how empty the stadium was. It reminded me of my recent trip to the US and research of video game publishers.
Declining viewership of sports isn't just an issue with rugby, most traditional sports have a diminishing supporter base and declining TV ratings. In contrast to this trend, multiplayer competitive video gaming, commonly known as e-sports is running hot. You only need to pick up the newspaper to witness the explosion around new game, Fortnite.
In 2017 385 million viewers tuned in to watch an e-sport event. Audiences have grown 24% yearly since 2014 and it is expected that viewers will grow to 850 million by 2025. The packed stadium pictured is the League of Legends video game World Championship!
The core driver behind this growth is the inclusive nature of video games — you don't have to be a professional athlete to get involved. There are over 2.2 billion gamers globally, playing video games that are competitive in nature. Another driver is being able to identify with your hero as they are in a similar age bracket (18-35) and are playing your game just like you, which is engaging. This compares to the ever widening gap between pro and amateur athletes in traditional sports. Top players like Tyler 'Ninja' Blevins, who is 27, can command up to 250,000 viewers per game and earn $500,000 a month from playing the hit game Fortnite.
Even though e-sports currently only generates around $2 of revenue per fan compared to $54 for other traditional sports in the US, there is a race from video game publishers, media companies and telecommunication firms to capture a slice of this rapidly growing market.
Also battling it out for eyeballs are the major tech giants. In 2014 Amazon brought video game streaming platform, Twitch and its 55 million monthly users (now 100 million) for $824 million. The website had only been founded 3-years earlier in 2011! It was reported that Google was also bidding for the streaming site. Through Twitch, YouTube (owned by Google) and Facebook gaming, viewers can subscribe to a gamers channel for between $5 and $25 a month or tip a player for skilled game play.
As active investors, finding growth themes is one thing, but finding companies with the ability to maintain competitive advantage over competitors, capitalising on the theme, is a lot harder. Through our investments in Facebook, Google (streaming platforms) and PayPal (online payments) we currently have indirect exposure to the rise of e-sports and online gaming. On recent trips to the US we have meet with all major US video game publishers, including Activision-Blizzard, Electronic Arts and Take Two, and also attended the E3 video gaming industry convention alongside 20,000 video game enthusiasts in Los Angeles. Our search for potential investments in this space continues. Investing is not about growth at all costs, it is also about capital preservation and ensuring the businesses you invest in have a franchise that ensures they will continue to profit for many years to come.
Image source: https://euw.leagueoflegends.com/sites/default/files/styles/wide_small/public/upload/photo-1_0.jpg?itok=2o14n4bd
There are two pieces of art on the wall next to my desk at work — both are quotes by Peter Lynch, the former manager of the rockstar Magellan Fund. The first is "There is absolutely no better investment technique than wearing out shoe leather and visiting companies". The second is "Know what you own and know why you own it".
There are two potential reactions to those pieces of art — either we need to inject some flair into our taste in art or, given that as the manager of the Magellan Fund between 1977 and 1990, Lynch averaged a 29.2% annual return, consistently more than doubling the S&P 500 market index and making it the best performing mutual fund in the world, perhaps we should heed his advice.
While the former may be true, we decisively follow the latter and agree whole-heartedly with Lynch's advice. There is no substitute for looking in the eye of the managers at a business — it accelerates the knowledge process and gives us confidence that there are layers of quality management below the "C" suite. Given more than 50% of the revenue from the NZ Growth Fund is derived from offshore, we recently visited several of the offshore operations of the portfolio companies in the NZ Growth Fund as well as global competitors of these companies.
One of the highlights of the trip was an opportunity to spend some time with the head of Xero's UK operation, Gary Turner.
Xero is the market leading provider of cloud-based accounting software for small-to-medium businesses and their accountants in NZ, Australia and the UK, with growing presences in the USA and other markets such as SE Asia and EMEA. We assume Xero will continue to be the innovators of the industry, allowing it to retain its market leading positioning in Australia/NZ and the UK, grow its foothold in the US market, as well as overtime, grow its rest-of-world business. Combined with the huge market opportunity (global penetration less than 3%) and the wide MOAT Xero is building around its small business customers, we think Xero has material future earnings growth and the UK will be a key driver of that growth.
The UK: a lucrative opportunity
Gary is one of the longest standing executives at Xero and has presided over the UK operations of Xero since inception almost 10 years ago.
Not only has the UK gone from less than 25,000 subscribers and less than 15% of group revenue 5 years ago to more than 325,000 subscribers and more than 20% of group revenue today, importantly we see the UK as the strongest revenue growth driver for the next 5 years.
Xero has around 1.4m customers globally today and we agree with Gary that there is no reason Xero cannot reach over 1m customers in the UK alone and we forecast them reaching that milestone within the next 5 years.
A powerful tailwind for the business is the UK government's mandate requiring firms to lodge consumption tax (VAT) returns digitally from April next year. Given approximately only 1 in 7 of the 1.4m VAT registered companies in the UK currently use accounting or tax software, this will help ensure the impressive growth rates we have been witnessing continue.
The secret to Xero's success in the still relatively nascent cloud accounting software market in the UK will continue to be great product, great people, strong relationships with the accountant channel as a key route to market and the courage to continue to be the innovator of the industry.
It is face to face meetings like this that are invaluable in building our further understanding of portfolio companies like Xero.