Monday, 03 April 2017 07:58

Why we don't like Telstra

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Telstra is a favoured stock among many retail investors, assumingly for the current high franked dividend.

While Telstra's balance sheet is in pristine condition, which would allow it the flexibility to borrow in order to support this dividend, we remain concerned about Telstra's earnings outlook.  Not only have earnings virtually gone nowhere over the past decade, the NBN is likely to pressure Telstra's future earnings in the absence of a new growth stragegy.

NBN is a game changer for all Australian telecommunications companies as it results in them becoming a reseller of the NBN service, rather than selling their own data networks which attracted a higher margin.  This is likely to leave a 'black hole' in earnings for Telstra in coming years once the NBN is rolled out.  This is clear in the table below.

While the above table is forward looking, there is not much joy in earnings in the rear vision mirror for Telstra share holders.  This graph shows earnings per share, which have virtually 'flat-lined' over the past decade.  Source of this data is Skaffold software.

We conclude this article with a 3 minute video from Michael Glennon (Small Cap Investor) who outlines the reasons he does not wish to invest in Telstra.

Over the last few years, there has been a significant increase in the interest in Environmental, Social and Governance (ESG) investing. According to a paper released recently, over $8trn of the $40trn of money managed in the USA is now under some form of Sustainable and Responsible Investing (SRI) or ESG, up 33% since 2014 and up fivefold from $1.4trn in 2012 for money run by fund managers.

In many respects Australian fund managers have been caught unready for this change. If we look at the Mercer survey data for January 2017, the Global Equities strategy section contains 127 global funds that are sold in Australia. Of this, only 5 are classed as SRI funds. It is somewhat better for Australian equities with 157 funds in the survey, of which 13 are SRI. If we were to use the ratio of assets in the USA, the number of SRI funds should be 27 and 34 respectively.

One reason could be that there is a view amongst many people (and particularly fund managers) that “you can’t have your cake and eat it too”: that SRI results in lower returns for investors and the investors have to pay a price to be responsible.

In some ways this misconception, of accepting lower returns for being ethical, goes against another tenant of conventional investing wisdom: buy good businesses. The grandfather of long term investing, Warren Buffett, discusses a lot in his letters to shareholders the importance of ethics and the quality of the character of the people running the businesses he owns.

Implicitly he is saying that businesses that have an ethos and focus on ‘doing the right thing’ by staff and customers, should generate higher returns. Now admittedly he is discussing the character of the people rather than the nature of the business, and some people would find owning Coca Cola unethical.

And it is this differentiation between good people and bad unethical businesses that opens an interesting next line of inquiry.  Download the complete 4 page report from Morphic Asset Management by clicking on the link below.

Australian shares delivering around 9%pa income sounds too good to be true.  In this article, we take a look at a couple of professionally managed investment strategies that have been able to achieve this over the last 5 years.

With cash rates at 1.5% and the Australian cost of living rising at a rapid pace, those who require income from their investments face a dilemma.  Do SMSF’s remain in cash and fixed interest and either burn capital, reduce their living standards due to the low rates, or do they pursue higher income strategies elsewhere.  According to the recent ATO statistics, the allocation of SMSF’s to cash and fixed interest  is 26% (Source ATO Annual Statistics overview)

The Australian share market currently offers investors a higher income yield than cash, with potential for capital appreciation over time as can be seen in the chart below.

While the income yield from Australian shares is above 5%pa (incl franking) some professionally managed funds employ strategies to enhance this yield for income hungry investors.

Plato Investment Management are launching a listed investment company (called the Plato Income Maximiser) which uses the strategy of the Plato Australian Shares Income Fund that has been in operation for over 5 years.  This fund is unique in that it is a long only fund (not using derivatives) that achieves higher income by buying securities on the ASX300 in the lead up to a dividend payment and then selling once the dividend has been paid.  Historical evidence shows that share prices tend to appreciate in the lead up to a dividend payment, which the fund uses to boost returns.  In the 5 years to 28th February 2017 this strategy returned income to investors of 9.1%pa with some capital appreciation.

CEO of Plato Investment Management, Dr Don Hamson talks about the Plato fund with Commsec in the video below.

 

 

 

 

 

 

 

 

 

 

 

 

 Other high income equity strategies focus on investing into high income stocks, and then bolster income by writing call options over some of their holdings.  A call option is an agreement that gives an investor the right but not the obligation to purchase a share at a specific price during a specific period in exchange for a financial payment.  Many investment managers offer this style of high income equity fund including Investors Mutual, Colonial First State, AMP just to name a few.

For example an investor who owns 1,000 CBA shares could write a call option that would allow another investor to purchase their shares for a set price of say $90 (currently CBA trading at around $83) and in exchange for this agreement, receives a payment.  This payment is considered additional income over and above the dividend that the investor receives. In the event that the CBA share price rose above $90 it is likely that the investor who wrote the call option initially, would be obligated to sell the CBA holding for $90. 

Therefore it is important to understand that an investment strategy revolving around writing of call options carries the risk of limiting the upside when share prices rise.  These strategies tend to outperform during flat or ‘down’ market conditions and underperform during strong markets.

We are not criticising equity income strategies that use call options, we are merely making a comparison which demonstrates the limiting of upside.  Below we have compared the Investors Mutual fund that use call options, to the Plato fund which does not.  The figures are to the end of February 2017 sourced from company websites.  Readers can see the limiting of upside returns in the strategy using call options over the last 12 months when the market has been positive.

 

Plato Aust Shares Income Fund 1 Year 3 Years pa 5 Years pa
Income 9.6% 9.1% 9.1%
Growth 13.3% -0.2% 4.7%
Total Return 22.9% 8.9% 13.8%

 

Investors Mutual Equity Income Fund 1 Year 3 Years pa 5 Years pa
Income 7.9% 8.3% 8.8%
Growth 6.9% 1.7% 3.3%
Total Return 14.8% 10.0% 12.1%

 

Both of these managers are highly rated, so the purpose of the comparison is not to place one manager above the other, simply to highlight the difference in strategies during a period of strong market returns (which is shown in the 12 month numbers).

We would also highlight that the soon to be listed, Plato Income Maximiser is a listed investment company, which is different to the other income funds which are available in the format of a unit trust.  The benefit for SMSF trustees of investing in a listed investment company structure is the ability of the company to smooth dividend payments, where as a unit trust must pay out all income received to investors during the financial year in which it is received.  This can result in income being somewhat ‘lumpy’.

Finally the other difference between a listed investment company and a unit trust is that investors can purchase units in a trust by purchasing them directly from the investment manager, where as a listed investment company must be purchased via the ASX, or in the case of Plato Income Maximiser, can be purchased in the IPO which closes in April 2017.

This blog article is of general nature only and describes the new fund and is not in itself making an investment recommendation.  Investors are urged to read the prospectus and seek professional advice before investing.  The prospectus can be downloaded by clicking on the 'Download' icon below.

Saturday, 25 March 2017 08:02

Morphic Ethical fund to list

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Jack Lowenstein and Chad Slater formerly from Hunter Hall are about to list the Morphic Ethical Equities fund.  Morphic was established in 2012 and has managed the Global Opportunities fund in that time which has generated a 17%pa return for investors since its inception.

Morphic Graph

 

Morphic is 30% owned by Westpac, and 70% owned by management, an ownership structure that we like.  Jack Lowenstein will be putting in significant money of his own into the listed investment company which is further evidence that management's interests are aligned with share holders.

The Morphic listed investment company will be aiming to pay out a steady stream of franked income once it has built up a profit reserve account and will invest ethically by not being to invest in companies that engage in:

Environmental Damage 

Oil and Gas

Gambling

Tobacco

Alcohol

Uranium Mining

Old Forrest logging

Morphic Ethical Equities fund will also have the ability to short stocks, (take a position to profit from a falling share price) and interestingly may short companies that fail it's ethical screen.

Investors who apply for shares in the IPO will receive a share of $1.10 in addition to an option for each share they purchase.  The option allows them to purchase an additional share at the same price of $1.10 in the next 18 months, or alternatively the option will carry some value and may be traded on the market.

We have spoken to the managers of the IPO - who have received good support from investors and they are anticipating that Morphic is likely to raise around $100m in this offer.

Management fee is 1.25%pa of net asset value of the fund which is reasonable for a global fund, plus a performance fee if the fund returns better than the international market.

GEM Capital is likely to receive an allocation of shares in this fund and the advisers will be co-investing into the fund too.

CEO Jack Lowenstein recently spoke on Sky Business News to Peter Switzer and we bring you that interview below.

Of course before investing, investors should seek professional advice and read the prospectus which can be downloaded below by clicking on the "Download" icon.

 

 

download button 1

 

 

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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