Thursday, 23 March 2017 08:59

China - It's better than you think

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Mark Draper and Shannon Corcoran (GEM Capital) recently spoke with Joseph Lai (Portfolio Manager Platinum Asset Management) about China and the current state of the economy.

Joseph believes that the Chinese market is cheap and that the risks of a banking crisis in China are overblown.

You can listen to the podcast here.

 

 

Apple RainbowApple is among the largest companies in the world.  The company enjoys strong brand recognition globally and extensive market penetration for its flagship products, most notably the iphone.  While speculation around the success of Apple Watch, Apple TV, iPad, or even the likelihood of an Apple Car often captures headlines, we estimate that iPhone and iPhone related services represented around 70% of Apple's revenue and 80% of Apple's gross margin in 2016.  Despite its relatively high price, there is strong demand for the iPhone in both developed and emerging markets, with China now contributing 21% of Apple's total revenue.

We recently met with Dom Guiliano (Chief Investment Officer, Magellan Financial Group) who outlined the investment case for Apple Inc, which is a major holding in Magellan funds.  You can listen to the podcast below.  You can also download the paper that briefly outlines the Investment Case for Apple, which clearly is far more than an electronic device manufacturer.  This can be downloaded by clicking on icon below.

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Tuesday, 28 February 2017 06:58

Donald Trump - the policy agenda

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The biggest event for global financial markets in 2017 is likely to have taken place on 20th January - when Donald Trump was sworn  in as the 45th President of the United States.

The implications for the US economy and financial markets from President Trump is likely to involve three phases.

Phase one was 'risk off', with the unexpected election victory by Trump seeing the US equity market and the US dollar sell-off and US bond yields rally.  This phase, however, lasted less than 24 hours, with the market quickly moving into the second phase.

The second phase, which ies expected to be the dominant factor throughout 2017, is supported by the view that Trump's policies will be expansionary and stimulatory - especially his company and income tax cuts, increased infrastructure spending and reduced regulatory environment.

This phase has already seen a strong rally in equity markets, the US dollar, a sell off in bond markets and is expected to be the primary factor driving markets throughout 2017.  A noticeable increase in both business and consumer confidence has taken place since the election.

Further out, however phase 3 may not be as positive.  Although the timing for phase three is very difficult to determine, it could be anywhere between 2018-2020, this phase is likely to involve an increase in inflation and a more aggressive monetary policy tightening cycle from the US Federal Reserve resulting in higher than expected interest rates.

In terms of the main policy agenda for President Trump, the following is expected (+, - and ? symbols indicate the direction of impact on the economy and markets)

+ Significant fiscal stimulus through a) large income tax cuts (3 rates 12%, 25% and 33%) b)company tax cuts (to 15% or 20% from 35%) and c) a 10% repatriation tax for cash currently held offshore by US corporates

+ Increase in infrastructure spending ie $300bn government spending, with private sector involvement potentially up to $1 trillion.

+ Increase in military spending - current and veterans

+ Reduce regulatory burden, especially on energy to achieve "complete American energy independance"

 

- Strongly protectionist stance - name China as a 'currency manipulator' and impose 45% tariffs on selected imported goods

- No support for TPP and change / withdraw from NAFTA - both important trade agreements

- Scale back climate change regulations

- Critical of US Federal Reserve policy, pro-audit, Chair Janet Yellen to be replaced in early 2018

- Isolationist stance of foreign policy - critical of NATO / some allies and China.  Closer to Russia.

- Tough stance on immigration - building a wall

 

? Repeal and replace Obamacare.

 

It has been estimated that Trump's policy agenda will increase the level of US Government debt by around 20% of GDP over the coming decade. 

 

 

 

The key question for investors over 2017 and beyond is wil this be money well spent?  Will President Trump's policies lead to a permanent shift higher in US's potentional economic growth rate?

This information is an extract from a presentation we attended by Stephen Halmarick (Chief Economist Colonial First State)

We will be producing a podcast that explores more about Trump's policy agenda in March with Dom Guiliano (Chief Investment Officer - Magellan Financial Group)

Monday, 27 February 2017 08:52

What the "Dumb" money is doing - Sportsbet on Trump

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Investing is a game of probabilities.  So is politics.

With the leading global book makers being wrong on Brexit and Donald Trump, they are now providing punters an opportunity to win their money back with Donald Trump, providing odds on Donald Trump being impeached, to visiting North Korea in his first term.

We provide screen shots from Sportsbet.com that highlight what's on offer.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Late last year OPEC announced that it will cut oil production by 1.2 million barrels per day to 32.5 million.  To put this number in perspective, OPEC represents around one third of global oil production.  These cuts will take effect in January 2017, lasting for 6 months and is the first time since 2008 that OPEC has cut production.  Currently although Iraq is producing more than agreed, the compliance from other OPEC members has been very high.

Already there has been some reaction in the oil markets with the price of oil rising in the last quarter of 2016.

Around 12 months ago, we shot a video featuring Clay Smolinski (Platinum Asset Management) who suggested that the oil markets would likely come into balance where supply meets demand during 2017.  This of course was well before the OPEC production cuts were announced, as the balancing of the oil market was underway at that stage.  The OPEC production cuts simply speed up the process.  The graph below confirms his prediction.

What stands out from the above chart is how close supply and demand tend to be.  Even when the oil market was in dramatic oversupply during 2015, the oversupply was around 2 million barrels per day.  The over-supply gap at the end of 2016 was small which underscores the significance of a production cut of 1.2m barrels per day.

It was also suggested at that time, that the oil price was likely to recover to around $70 per barrel as it is at this level that oil companies can make sufficient profit to reinvest into exploration to ensure supply can be maintained.  Currently the oil price remains in the $50 - $55 per barrel range, but the production cuts, providing they are maintained are only starting to be reflected in oil inventories now.

Higher oil prices are positive for companies who derive income from oil or products referenced to the oil price such as LNG.

At GEM Capital we have been investing in companies that can benefit from a rising oil price, and with fund managers who also share this view such as Ausbil and Platinum Asset Management.

Wednesday, 08 February 2017 16:27

Hunter Hall Global Value - Business as usual

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James McDonald (interim Chief Investment Officer for Hunter Hall) recently spoke with Commsec about the resignation/departure of Peter Hall from the business.

James talks about the depth of the Hunter Hall team, the current fund positioning as well as the future dividend policy.

 

 

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Wednesday, 08 February 2017 16:15

10 themes to watch in 2017

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This time last year, JCB Advisory Board Economist, Saul Eslake warned of the risks of a Yuan devaluation: “A large devaluation of the Yuan would add renewed impetus to the deflationary pressures that policymakers in advanced economies are hoping will ebb this year.” This proved prescient as markets saw a sharp risk-off correction in the first months of the year. By contrast, inflation is a key theme to watch this year, as headline inflation, core inflation, and producer price inflation all begin to show signs of life. This is just one of ten themes identified in this year’s ‘What to watch.’ Livewire and Jamieson Coote Bonds are pleased to provide exclusively for readers the top themes to watch this year from one of Australia's pre-eminent economic minds, Saul Eslake. 


By Saul Eslake, Jamieson Coote Bonds Advisory Board Member & Senior Economist. Saul Eslake was Chief Economist of ANZ Bank from 1995 to 2009, Chief Economist at National Mutual Funds Management in the early 1990s, and acted in various advisory roles to the Howard, Rudd, and Gillard governments.

Saul-Eslake.png


"Over the first few weeks of the year, I’ve been thinking about the issues that I’m likely to find myself talking about at conferences and events in the coming year. Here are ten things that I think are likely to shape the global and Australian economies during 2017.

1. What Donald does (or says) next: This time last year I wrote that Donald Trump was ‘odds on’ to be the Republican nominee for President of the United States, but I also found it ‘hard to conceive’ that he could be a ‘serious contender for what used to be called Leader of the Free World’. Moreover, I thought that financial markets around the world ‘may well take fright’ if they began to think that he and Melania ‘could be moving into the White House’. Well, Melania isn’t moving (yet) – but Donald Trump is now ensconced in the White House; and although they didn’t predict his victory either, they haven’t been at all troubled by it (so far). Since the election, investors seem to have assumed that President Trump will only seek (or be allowed by Congress) to implement the items from his campaign platform which markets believe will boost economic growth (such as cutting taxes and boosting infrastructure spending), and that he will back away from (or Congress will block) items from his campaign platform which would harm growth (such as launching trade wars). However, Donald Trump’s inaugural address casts a lot of doubt on those convenient assumptions. I think his assertion that ‘protection will lead to great prosperity and strength’ is complete and utter balderdash – but it’s also a clear signal that he means to implement the protectionist agenda he repeatedly outlined during last year’s election campaign. And, as a result, we are likely to see much more volatility in market pricing of the outlook for the US and global economies – and, eventually, if the Trump Administration is able to implement this protectionist agenda, weaker growth, higher unemployment and higher inflation.

2. European voters: There are a number of important elections in Europe this year – including in the Netherlands on 15th March, in France on 23rd April and on 7th May, and in Germany sometime between late September and late October. Each of these will provide some insight into the extent to which the wave of right-wing populism which gained global attention in the ‘Brexit’ referendum and then during the US election campaign continues to appeal to voters. The Dutch Parliamentary and French Presidential elections, in particular, could add to the number of countries seeking to exit the European Union. And then of course there are the various formal steps which Britain needs to undertake in order to give effect to last year’s referendum verdict. All of these represent potential sources of market volatility.

3. The clash between demography and economic policy: Markets – and many policy-makers – seem to be paying scant regard to the constraints which demographic change has been having – and will increasingly have – on the rates of growth which can be sustained by advanced (and some emerging) economies. Across the OECD area, the growth rate of the 15-64 year old population has slowed from 0.75% pa in 2006-08 to just 0.2% pa in 2016- 18. This largely explains why OECD area real GDP growth averaging just under 2% pa since the trough of the ‘Great Recession’ in early 2009 – a rate some two-thirds of a percentage point below the average between the global recessions of the early 1990s and the onset of the financial crisis – has nonetheless been sufficient to allow the average unemployment rate across the OECD area to fall by more over the past three years than over any other three-year period, bar one, in the last five decades. That fall in unemployment is of course a Good Thing. But now that the unemployment rate in the OECD’s four largest economies is down to levels traditionally regarded as consistent with ‘full employment’ – while in those OED countries where unemployment hasn’t fallen by very much, it’s mostly ‘structural’ rather than ‘cyclical’ unemployment, which faster economic growth alone can’t help – ongoing efforts to procure a return to pre-crisis economic growth rates are more likely to trigger higher inflation than faster growth. That’s especially so if productivity growth remains as anaemic as it has, in virtually all advanced economies, since the financial crisis. And in this kind of world, protectionist policies amount to a fight over shares of a shrinking economic pie – they do nothing to make the pie bigger.

4. The end of deflation fears: Largely because the four major advanced economies are now effectively at full employment, the fears of falling into deflation which have periodically gripped financial markets since the financial crisis should evaporate. ‘Headline’ inflation rates have picked up (in some cases out of negative territory) since the middle of last year, aided by the rebound in oil prices. ‘Core’ inflation rates also appear to be edging higher in most advanced economies, especially in the UK (as a result of the post-referendum fall in sterling) and in the US. Producer price inflation across Asia also moved back into positive territory towards the end of last year, something which will filter into advanced economy consumer prices during 2017. This should eventually see an end to negative interest rates around the world.

5. The Fed: The Fed repeatedly baulked at raising interest rates last year, eventually doing so only at the last opportunity, in December. This left the Fed open to accusations from Donald Trump that it was ‘artificially’ holding rates down in order to favour his political opponent. As President Donald Trump is now in a position to reshape the Fed, with two vacancies on the Fed’s Board of Governors able to be filled immediately, and the opportunity to appoint a new Chair and Vice-Chair early next year when Janet Yellen’s and Stanley Fischer’s terms in those offices expire (although they could complicate matters by electing to serve out some or all of their remaining terms as Governors). During last year’s election campaign Donald Trump also appeared sympathetic to proposals to water down the Fed’s independence from political interference. At its December meeting the Fed foreshadowed its intention to raise interest rates three, or possibly four, times during 2017. The Administration’s reaction to such moves, as well as the calibre of its appointees to the Fed, may have an important bearing on market perceptions of the Fed’s credibility as the year unfolds.

6. China: The ‘Chinese authorities’ succeeded in shoring up China’s growth rate, staunching the outflow of capital, and stabilizing the currency during 2016. Nonetheless, uncertainty about the future trajectory of the Chinese economy, and the response of the ‘Chinese authorities’ to the various policy dilemmas which they face, will remain throughout this year. The form taken by last year’s monetary policy stimulus – whereby banks were encouraged to borrow in wholesale money markets in order to fund purchases of local government securities and loans to non-bank financial intermediaries – has introduced a new element of risk into the Chinese financial system. For the first time, the ratio of loans to deposits of Chinese banks has dropped below 100% - and is continuing to fall – implying that the Chinese banking system is starting to become exposed to liquidity risks of the sort (albeit not yet on the same scale) that were at the heart of the Asian financial crisis of 1997-98 and the global financial crisis of 2007-09. The ‘Chinese authorities’ may be fearful of allowing the yuan to depreciate further against an appreciating US dollar for fear of further inflaming the protectionist instincts of the Trump Administration. And of course they may have to decide whether, and if so how, to retaliate to any specific protectionist measures directed at China by the Trump Administration. Outside of the purely economic sphere, tensions between China and the US over the former’s activities in the South China Sea, and the latter’s relationship with Taiwan, could also prove unsettling for financial markets.

7. Australia’s on-going economic transition: Australia’s economy is continuing its hesitant and uneven transition away from growth driven by the mining investment boom (which peaked in 2013) to growth driven by a variety of other, often less visible, sources. The upswing in dwelling construction, which has accounted for more than one-third of the non-resourcesexports-related increase in real GDP over the past two years, appears to have peaked – and although there is still plenty of work left in the residential building ‘pipeline’ this sector is unlikely to provide much further impetus to economic growth in 2017. The renewed upswing in lending to investors is potentially worrisome (since the main effect of domestic property investors is to inflate housing prices, rather than to add to housing supply), and may require further attention from APRA. There’s still not much sign of any imminent pick-up in other categories of investment. Consumer spending should continue to grow at a modest pace, given subdued growth in both wages and employment, and the on-going absence of fiscal stimuli of the type that became routine during the commodities boom years

8. Domestic politics and the Budget: The Turnbull Government is in a much weaker position than seemed likely this time last year – with a wafer-thin majority in the lower house, a fractious assortment of cross-benchers holding the balance of power in the Senate, and an ill-disciplined and restless backbench, all as a result of the Government’s poor showing at last July’s election. The Government lacks any kind of strong mandate for economic reform – with its signature initiative, the ten-year staged reduction in the company tax rate, unlikely to gain legislative approval, and there being no readily apparent ‘Plan B’. Moreover, despite Malcolm Turnbull’s promise to preside over a ‘thoroughly liberal government’, his Government seems surprisingly beholden to protectionist and other right-wing influences, both from within and without. This tendency will only increase if Pauline Hanson’s One Nation party does well in the State elections to be held in Western Australia on 11th March and Queensland most likely later this year. Another key milestone will be the Budget on 9th May – where the Government will again be under pressure to re-assure credit rating agencies and others that the budget really is on a credible path back to a sustainable surplus, and not one reliant on accounting policy changes.

9. The RBA: It will take a lot to get the Reserve Bank to move Australian interest rates – in either direction – this year, although no-one should doubt their willingness and ability to do so if they think it’s warranted. Newly-installed Governor Phil Lowe’s previous writings have prompted some to think that he places more weight on financial stability considerations than his predecessors, and hence will be less inclined to cut interest rates and further – and possibly more willing to raise them. However to date he hasn’t really said or done anything to justify that conclusion. He appears to share the (sensible and pragmatic) view held by his predecessor, in his final year as Governor, that monetary policy was approaching the limits of what it could do to improve Australia’s economic growth prospects, and that fiscal policy and productivity-enhancing structural reforms should play a greater role. Global developments suggest that Australia’s inflation rate should edge higher, in line with the RBA’s own forecasts, from its late 2016 levels – in which case there shouldn’t be any need for further rate cuts. On the other hand, it’s also hard to see Australia’s economic growth performance picking up so strongly as to warrant one or more rate hikes this year.

10. Property prices: No discussion of the Australian economy, or Australian interest rates, would be complete without at least some reference to the residential property market. Actually to speak of ‘the’ residential property market as if it were a single homogeneous entity is even more misleading than usual under current circumstances, with Perth and Darwin prices down 8% and 6%, respectively, from their peaks but Sydney and Melbourne prices putting on more than 15% and nearly 14%, respectively, last year. There is, to be sure, a lot of new supply hitting the Melbourne, Sydney and Brisbane markets over the next few years, which in theory should put a lid on further price appreciation: but there is also quite strong population growth, particularly in Melbourne, to absorb at least some of that new supply. And there is absolutely no political will on the part of the present Government to do anything to restrict the scope for domestic investors to continue inflating existing property prices. The renewed upturn in lending to investors towards the end of last year will, if it continues, be of some concern to the RBA, but they’re unlikely to raise interest rates for that reason alone, and will instead likely leave that problem to APRA. A US-, Irish- or Spanish-style ‘meltdown’ in Australian property prices won’t happen without a specific trigger, and it’s hard to see one on the near-term horizon: but the more prices keep going up, the greater the risk of either some kind of ‘accident’ (which could emanate from somewhere outside of Australia, such as China) or, alternatively, a growing social and political backlash against the ongoing deterioration in housing affordability."

Saul Eslake, Jamieson Coote Bonds, Advisory Board Member & Senior Economist.

23rd January 2017

It has been rumoured in many media outlets that Amazon will commence operations in Australia next year.  Richard Goyder (CEO Wesfarmers) has often quipped that Amazon won't just 'eat our lunch, they will eat breakfast and dinner too'.  So with such a large threat to the status quo of retailing in Australia, many of whom enjoy some of the largest retailing margins in the world, we examine what this may mean for investors.

It may comes as a surprise  that online penetration is less than 15% in most developed countries - in fact many countries online presence is below 10%.

Source:  Forager Funds Management

 

Clearly when Amazon commences operations in Australia, there will be much fanfare, but investors need to ask how much market share are they likely to pick up.  the next chart shows Amazon's share of online retail sales.  While Amazon is the largest online retailer in the US and Europe, it by no means has a majority share of these markets.  Globally it tends to gain about a 15-20% share of e-commerce.  If the same mathematics was applied to the Australian market, Amazon could expect to gain around 1 - 1.5% of total retail sales.

Source:  Forager Funds Management

 

Finally we consider that not all retailing is equal when approaching the idea of online sales.  The furniture division of Amazon has been a 'disaster' while apparel and electronics have shared greater success.  When we approached the subject with senior management at Perpetual, they said "Fresh Food would be almost impossible for Amazon".  The last chart is a summary from the Aust Financial Review outlining the view of Citigroup of the market share that Amazon is likely to gain in each market segment.  The chart also highlights an estimate of earnings lost by the incumbent retailers assuming these market share estimates prove correct.

 

 

 

We have nothing but respect for Amazon and their business model, and investors are encouraged to ensure that their investment strategy takes into account the likely entry of Amazon into the Australian market in 2017.

 Key points

 

Introduction

After a seemingly long and difficult campaign Donald Trump has been elected president of the United States with the Republican Party retaining control of the House, and the Senate, in Congress. Just as we saw with the Brexit vote, the combination of rising inequality, stagnant middle incomes and the disenchantment of white non-college educated males has seen a backlash against the establishment and helped deliver victory for Trump. This note looks at the implications.

 

Trump’s key policies

Taxation: Trump promises significant personal tax cuts including a cut in the top marginal tax rate to 33% from 39%, a cut in the corporate tax rate to 15% from as high as 39% and the removal of estate tax.

Infrastructure: Trump wants to increase infrastructure spending.

Government spending: Trump wants to reduce non-defence discretionary spending by 1% a year (the “penny plan”), but increase spending on defence and veterans.

Budget deficit: Trump’s policies are likely to lead to a higher budget deficit and public debt.

Trade: Trump wants to renegotiate free trade agreements and has proposed various protectionist policies, eg; a 45% tariff on Chinese goods, 35% on Mexican goods.

Regulation: Trump generally wants to reduce industry regulation, which would be good for financials and energy.

Immigration: Trump wants to build a wall with Mexico, deport 11 million illegal immigrants, put a ban on Muslims entering the US and require firms to hire Americans first.

Healthcare: Trump wants to repeal Obamacare and allow the importation of foreign drugs.

Foreign policy: Trump wants to reposition alliances to put "America first" and get allies to pay more, would confront China over the South China Sea and would bomb oil fields under IS control.

Risks and uncertainties

A problem for Donald Trump and America is that he will start his Presidency as extremely unpopular – in fact he is the least popular candidate on record and the election campaign has also highlighted a deeply divided America.


Source: Gallup, BCA Research, AMP Capital

He also faces a difficult time negotiating with his Republican colleagues in Congress given many distanced themselves from him during the election campaign.

Trump’s victory, like the Brexit vote, adds momentum to a backlash against establishment economic policies and specifically a move away from economic rationalist policies in favour of populism and a reversal of globalisation which could be a negative for long term global economic growth. The shift away from globalisation could also add to geopolitical instability (Russian President Putin was a supporter of Brexit and Trump!). More positively though, a greater focus on using fiscal stimulus could help reduce the burden on monetary policy and policies to reduce inequality could help support longer term economic growth.

Economic impact

Some of Trump’s economic policies could provide a boost to the US economy. The Reaganesque combination of big tax cuts and increased defence and infrastructure spending will provide an initial fiscal stimulus and, with reduced regulation, a bit of a supply side boost to the economy. The downside though is that this will blow out the budget deficit and the risk is that his protectionist policies will set off a trade war, and along with much higher consumer prices and immigration cut backs will boost costs. All of which could ultimately mean higher inflation and bond yields and a faster path of Fed rate hikes in the US (apart from any initial delays associated with uncertainty around his policies).

There may also be negative geopolitical and social consequences - tensions with US allies, reduced inflows into US treasuries in return, a more divided America - if Trump follows through with policies on these fronts.

Australia being more dependent on trade than the US (exports are 21% of GDP in Australia against 13% in the US) will be particularly vulnerable if Trump were to set off a global trade war.

The ultimate impact will depend on whether we get Trump the populist (determined to push ahead with his protectionist policies and steam roll Congress) or Trump the pragmatist (who backs down on his more extreme policies, eg. around protectionism) leading to a smoother period for the US and global economies. If we get Trump the pragmatist there is a good chance the US will see a sensible economic stimulus program combined with long needed reforms in areas like corporate tax.

Likely market reaction

The last few weeks – with shares and other risk assets falling when developments favoured Trump and rallying when developments favoured Clinton – indicates Trump’s victory will not go down well with markets. In fact we have already seen this with the initial reaction in Asian markets:

  • Trump’s victory is seeing a resumption of “risk off” with shares likely to fall 5% or so (both in the US and globally – although Asian and Australian shares have already reacted to some degree) and safe havens like bonds and gold rallying as investors fret particularly about his protectionist trade policies triggering a global trade war. Australian shares are particularly vulnerable to this given our high trade exposure. The “global shock” of a Trump victory will likely see the Yen and the Euro rally further against the $US but the $US rise further against the Mexican peso and trade exposed countries in Asia.
  • While the Fed will be a bit less likely to hike in December with a Trump victory, the $A will likely suffer from the threat to trade and the initial “risk-off” environment. A Trump victory to the extent that it leads to falls in investment markets and worries about a global trade war, may also increase the chance of another RBA rate cut in Australia – but not until next year.
  • Beyond the initial reaction, share markets are likely to settle down and get a boost to the extent that Trump’s stimulatory economic policies look like being supported by Congress, but much will ultimately depend on whether we get Trump the pragmatist or Trump the populist. Congress, along with economic and political reality, can probably be relied on to take some of the edge off Trump’s policies to some degree, but this would take time. But a more pragmatic approach by Trump to economic policy would probably see the initial market reaction present investors with a buying opportunity.

Historically since 1927 US total share returns have been weakest when Republicans controlled the presidency and Congress with an average return of 8.9% p.a.


Source: Bloomberg, AMP Capital

Concluding comments

While Trump’s victory will come as a bit of a shock to many, there is a good chance that economic realities and the checks and balances provided by Congress will see his policies become more pragmatic. A good initial guide to this will be what sort of advisers Trump appoints around him. And remember there was much concern a Yes Brexit vote would be a disaster for shares and the global economy. What actually happened was an initial knee jerk sell off but after a few days global markets moved on to focus on other things and shares rallied. So there is a danger in making too much of the US election. It’s also worth noting that recent global growth indicators have been improving – both business conditions PMIs and profit indicators – and this along with continuing ultra-easy global monetary policy provides support for investment markets in the face of short term political uncertainties. 

Finally, while the Presidential election is an important political event, investors should remain focused on adhering to their financial objectives, ensuring that their portfolios are well diversified across asset classes and geographies, and continuing to take a long-term view.

Tuesday, 01 November 2016 08:01

Should investors participate in IPO's

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This article was written for SMSF Adviser online magazine.

 

With the avalanche of new listings coming to market, we consider the issue should investors participate in IPO’s (Initial Public Offers)?

When it comes to investing we all aspire to Warren Buffett, and yet at times investors act more like Gordon Ghecko, the fictional character portrayed by Michael Douglas in the 1987 film “Wall Street”. This is how it seems with the love affair investors have with IPO’s.

Every investors dream of course is to buy into a float, and then sell day one for a handsome profit, otherwise known as a ‘stag’.

We acknowledge how easy it is to fall in love with a new IPO, after all the prospectuses produced usually come complete with stunning pictures of celebrities such as Jennifer Hawkins who made the Myer prospectus worth flicking through. When Pacific Brands pitched to investors the images of Pat Rafter and others in their underwear may have been visually appealing, but certainly not instructive.

Aside from the pictures though, the prospectus almost always outlines a rosy outlook for the business.

The first question we would suggest investors ask themselves is – would they want to have this in their portfolio in 5 years time? If the answer is a clear no – then we suggest extreme caution.

Other than the normal set of investment considerations that investors think about when investing, such as price, management, gearing etc here are a series of additional points when thinking about investing in an IPO.

  1. Investors need to understand who is the vendor of the IPO. Private Equity funds have established a poor reputation for taking over businesses, loading them up with debt after stripping the company of other assets before selling back to unsuspecting investors via an IPO. Dick Smith comes to mind as a perfect example. We are not opposed to buying from Private Equity funds as such, but investors must understand that the vendors in an IPO have a far greater understanding of the business than the investor can gather from reading the prospectus, which puts the vendor at a significant advantage. Conversely the history of Government IPO’s has been a little friendlier for investors, other than of course Telstra II, which is still significantly underwater from its $7 plus offer price.
  2. Once investors have established who is the vendor, it is important to also understand whether the vendor is retaining any part of the company or if it is a full sale. If the vendor is retaining part of the business, investors need to understand if there are any time limitations around this ownership. We also believe that it is also crucial to understand what the IPO proceeds are being used for. Is the IPO simply to reduce debt, or for the vendor to sell out? Or are the proceeds being used to grow the business?
  3. Brokers are remunerated for selling the IPO. While this may sound obvious, it reminds us of the phrase “never ask a barber whether you need a haircut”. Brokers have to sell their services to the IPO vendor, which results in a research blackout on the IPO company. This simply means that it is virtually impossible to obtain unbiased investment research from the broking firm that is handling the IPO. And of course as the experienced brokers will tell you – “the best IPO’s you can never get enough of, and the IPO that you receive your full allocation for is generally the one you don’t want”
  4. One of the best pages of the prospectus is the “Investment Risks” section. In our experience, very few investors read much in a prospectus at all, and in particular do not read or understand the investment risks section. If it is one section of a prospectus that investors read, it should be this section.

So, should you invest in IPO’s? Our view is that while some IPO’s offer good opportunity, greater caution should be exercised by investors when considering IPO’s due to the lower level of information usually available.