COVID-19: an investment perspective

What is happening with the outbreak of COVID-19 is most certainly a human tragedy for those impacted by the virus. Its spread beyond China into (in particular) Iran, South Korea and Italy has also seen global investment markets tumble in dramatic fashion. As I write this, the US Dow Jones Index dived 2,000 points overnight – the largest daily points loss ever. And it isn’t just the US. Share markets around the world, including New Zealand, are a sea of red numbers today.

World stock market reactions to COVID-19 appears to assume a worst case scenario: a global pandemic, a non-seasonal virus, broad behavioural changes leading to significant reductions in demand, and a global recession which might continue for some time. I am not by any stretch of the imagination a public health expert, but from what I have read, this seems to downplay the potential – even the likelihood – of less catastrophic outcomes. For example COVID-19 not becoming a pandemic, a seasonal virus, more localised behavioural changes, a quicker recovery, and less economic disruption.

Markets are often driven by fear and greed, and can be prone to overreacting. I don’t know if this is the case with COVID-19, but it wouldn’t surprise me if it was.

People investing in shares should have a medium to long term investment horizon and my advice is to keep calm and stay invested. If you have been regularly adding to your investments (eg. buying monthly), keep doing so. You can think about this period as buying shares on sale. But don’t panic and sell, and particularly don’t try to pick the bottom to make a quick buck. History and research says you are most likely to get it wrong.

I don’t have a crystal ball, but I suspect that in the relatively near future, we will be able to look back on COVID-19 as a blip – down and then up. Until then, as an investor its time to buckle up and try to enjoy (or at least endure) the ride.

 

Dean Edwards

A Decade of NZ Equities

The start of a new decade is always a good time to look back and reflect on what has gone before. From an investment perspective, a decade is also an excellent timeframe to review long term performance of growth assets like shares and property, as it covers a full economic cycle (generally considered to be about 8 years).

The 2020’s was an outstanding decade to be invested in New Zealand equities. The benchmark MSCI New Zealand Index averaged annual gains of 12.8%, while avoiding any scary collapses like what was seen in the previous decade with the global financial crisis in 2008. The worst year was a -5.4% decline in 2015, and the best was 2019 with a 38.8% gain.

While doing some research for this blog post, I came across the following colour coded chart of annual share market returns – highest to lowest – for developed market countries outside of the US, which goes back 15 years (New Zealand is teal coloured):


International Stock Market Returns

 

There are a few things worth highlighting:

  • The GFC in 2008 was a scary time to be an investor, and thankfully we didn’t see a collapse even remotely close to this during the 2010’s. But it is also instructional to note how markets rebounded from the GFC in 2009. The moral of this story … don’t panic and stay the course.
  • Not that we are competitive, but … the New Zealand share market has generally outperformed Australia over the last 10 years, culminating in New Zealand leading the developed world for market returns in 2019! But Australia is still slightly ahead over the full 15 year timeframe of this chart (7.53% v 7.50%).
  • As can be seen from the patchwork of colours, relative performance is quite random. As an example, New Zealand went from 2nd bottom in 2017 to 2nd top in 2018! Being well diversified is key as it is near impossible to predict the country winners and losers.

Overall, the 2010’s were a tremendous decade to be invested in equities, and not just in New Zealand. For most of the decade the bulls were in charge, producing stellar long term returns. Bears were rarely sighted, and when they did claw back gains, they didn’t drag markets down too far.

Dean Edwards

 

Property investment: residential or commercial?

There is no doubt that New Zealanders love residential property as an investment.  The reasons why are easy to note: property is a tangible, easily understood investment – you can see it, touch it, manage it yourself (if you choose).  It generates cash via rent, offers some tax advantages, and generally speaking capital gains have been stellar over the last 20 years, although the market has been flat at best in Auckland for the last 3 years.  

Partly this love of property also dates back to the NZ share market surge and subsequent world-worst crash in the late 1980s.  Many people over 50 today were burnt badly, and have avoided shares ever since.

But for investors looking for exposure to property, commercial property may be a better option – particularly by investing in listed commercial property companies that each own a significant portfolio of commercial properties.  In New Zealand, this is through companies such as Kiwi Property Group, Goodman Property Trust, Precinct Properties, Stride Group, etc. 

The advantages of listed commercial property compared with residential property are:

  • Part ownership.  Rather than buying an entire residential property, investors can enjoy part ownership by buying shares in the listed property company.
  • Liquidity.  Similar to above, investors can sell some or all of their listed commercial property investment on the NZ share market.  Much quicker and easier than selling a house.
  • Yield.  Commercial property typically generates a higher income yield (rental income as a percentage of purchase price) than residential property.  In a market like Auckland, where residential yields can be below 3%, the difference can be significant – commercial property yields above 6% are common.
  • Costs.  Costs are usually lower for commercial property v residential property.  This includes the cost of property management.
  • Diversification.  Listed commercial property companies own a number of properties, often in different geographical areas and sometimes across different segments of the commercial property market – industrial, office and retail.

Overall, property of any description is an excellent growth investment which has the added advantage of generating strong cash flows.  It often performs well when equity markets are in retreat or when interest rates are low, and helps to reduce overall portfolio volatility.  But investors should consider commercial property as an alternative to residential property due to its easier accessibility and superior liquidity.

 

Dean Edwards

 

KiwiSaver Update

KiwiSaver, which began in 2007, is undoubtedly a NZ retirement success story, having grown to around $50 billion invested in the 12 years since its inception.

There are many aspects of KiwiSaver which make it a no-brainer for most people, including:

  • deductions that happen automatically (before you have a chance to miss the money)
  • the payment from the Government each year (free money)
  • matching employer contributions up to 3% (free money)
  • a good range of different KiwiSaver providers and different investment approaches (choice)
  • the ability to use your KiwiSaver to fund a first house purchase or for financial hardship (flexibility)

There are also several changes that came into effect on 1 April this year which are worth noting:

  • a broader set of contribution rate options, now 3%, 4%, 6%, 8% or 10%, although note that most employers will still only match your contribution up to 3%
  • a break from contributing to KiwiSaver is now called a Savings Suspension, not a Contribution Holiday (which sounded too positive!)
  • the payment from the Government is now called a Government Contribution, not a Member Tax Credit
  • People over the age of 65 can join KiwiSaver (from 1 July), and there is no lock in period before they can make withdrawals.

The last point is significant as it will open the door to some KiwiSaver products which are great for over 65s, but to date have been inaccessible if the person wasn’t already a KiwiSaver member.  For example, the Guaranteed Income KiwiSaver Fund offered by Simplicity, which provides an ongoing annuity payment, and is a good way to generate a regular income stream from your retirement savings.

Dean Edwards

Auckland residential property as an investment

I often end up discussing the merits of residential property as an investment with clients.  As I am Auckland based, as are most of my clients, this is usually specifically relating to Auckland residential property.

There is no doubt that the Auckland housing market has seen spectacular growth over the last 20 years.  From 2001 to 2017 average house prices increased by around 170%, fuelled it would seem by a combination of rapid population growth and low interest rates.

But Auckland house prices have plateaued.  There has been little change from around September 2016 until now.

In my view, the major factor in the cessation of growth is that affordability limits have been reached.  Houses have simply become too expensive for many prospective purchasers to afford.

In addition, a raft of public policy changes have been introduced to alter the demand/supply balance or to improve affordability, including:

  • Auckland Unitary Plan rezoning
  • Special Housing Areas (National) and KiwiBuild (Labour)
  • Loan to value ratio restrictions
  • Foreign buyer restrictions

And more are coming:

  • Removal of ability to offset rental cash flow losses against other income
  • Capital gains tax changes
  • More favourable terms and rights for tenants

A net result of all this is that I am cautious about the short/medium term prospects for Auckland residential housing as an investment.  My feeling is that the current flat housing market may continue for an extended period (perhaps many years), but there is also potential for market declines due to the combined impacts of the above policies, with additional risks if interest rates begin to rise.  I’ve heard a number of times that the Auckland housing market will never fall, but I’ve seen it first hand when I lived in London, and it is currently happening in Melbourne and Sydney.

My preferred property investment is commercial property.  Prospects for the sector are generally good, rental yields are significantly higher, it’s an easy investment to access via property companies or property funds (which also provides diversification and liquidity).  And finally commercial property is an excellent defensive investment – often performing well when equity markets are struggling.

Dean Edwards

Equities are on sale!

Well, its been a wild ride for equity markets over the last quarter of the year.  In fact, a bumpy downhill slide might be a better way of characterising what has happened.  All major markets are significantly down over the quarter.  As I write, the major market indices have fallen 7% for New Zealand, 12% for Australia, 11% for the UK, 14% for Japan and 13% for the US from their high points in September.

I’ve yet to come across an investor who enjoys seeing the value of their investment portfolio fall.  But in fact, significant market corrections, the likes of which we are going through now, do represent good buying opportunities.  A good way to look at it is that equity markets are currently “on sale”, and it’s a good time to get a bargain.

This is where portfoilio rebalancing comes into its own.  All investors should have defined an appropriate asset allocation based on their personal situation, financial objectives and risk profile. As an example, a “balanced” investor, might have a benchmark portfolio of 50% growth assets (shares, property) and 50% defensive assets (fixed interest, cash). 

But now, with the market turmoil, that balanced investor may find that equities only account for 40% of their total portfolio.  This is a strong signal to convert some fixed interest funds into equities, to return the weightings to 50/50.

This can be hard to execute. If markets have fallen, it can feel very wrong to be buying.  But it is the right strategy to maintain an appropriate risk profile (avoiding your portfolio becoming too risky or too conservative). And if done well it’s a structured way of buying low and selling high, and can make a meaningful difference to your long term portfolio returns.   A note here that you should also rebalance when the opposite happens i.e. when equity markets surge ahead.  This is a sell signal, to again return your portfolio to its benchmark asset allocation.

Going forwards, there are a few global issues that might make markets jumpy in the short term: US/China trade tensions, Brexit, rising US interest rates, etc.  I encourage investors to keep a long term perspective, stay invested, don’t get spooked by short term market volatility, but do look for opportunities to rebalance when the markets are having a sale.

Happy holidays!

Dean Edwards

The emotional impact of market downturns

A rocky month of October for equity markets has come as a rude wake up call for many investors who had become comfortable with several years of steadily increasing returns.

How you feel about your investments during the bad times is often a great way to assess whether you have the right mix of growth and defensive assets in your portfolio.

To illustrate this, consider the portfolio outcomes for and an aggressive investor (100% equities) and a balanced investor (50% equities, 50% fixed interest) during short, medium and long term periods where equity markets fell.  This is based on the actual yearly returns of the benchmark US S&P500 Index:

 

Investment portfolio performance during the following periods: Aggressive Investor Balanced Investor
One bad month (October 2018) -7% -3%
One bad year (2008) -37% -18%
Three consecutive bad years (2000-2002) -42% -20%

Ask yourself whether you could cope with seeing your investments fall for 3 years in a row, and over 40% in total, which is what happened in 2000-2002?  Or if you could handle a 50% drop in 2007/8? (for calendar year 2008 the fall was -37%)

If the answer is no, then you are probably better off having some defensive assets in your portfolio (eg. bonds, fixed interest investments), which usually provide steady returns even when equity markets are tumbling.  The above table shows how a balanced investor would have faced losses less than ½ as much as an aggressive investor, during the same negative periods.

For the majority of investors, having some defensive assets in their portfolio helps to cushion the fall during market downturns, plus provides a pool of money that can be used to rebalance a portfolio if indeed equity markets do fall significantly, by buying more equities when they are cheaper.

Yes, this approach will come at the expense of greater returns when markets are rising, but if your losses during crashes are not catastrophic, you will feel better emotionally, and you are more likely to stay the course and not panic sell at the worst possible time.

 

Dean Edwards

 

Musings from the US

I recently returned from a 2 week vacation in the US (it was great to briefly escape the miserable Auckland winter!).  While in the States, I couldn’t help make a few very unscientific observations, based purely on what I did and what I saw:

  • The parts of the US economy most visible to a tourist appear to be thriving.  I’m talking airports, hotels, shops, restaurants, night spots, attractions, etc.
  • The scale of the US (and the US economy) is just so big.  You notice this particularly when you see the size of the transport networks, the massive ports, criss-crossing airport flights, vast industrial areas, and extensive competition for just about everything.
  • More than any previous overseas trip, I was totally reliant on the services of major US technology companies.  I used Google Maps and Google searches constantly; I stayed connected via Microsoft OneDrive and handled emails with Outlook; transport was often via Uber or Lyft;  I shopped on Amazon and ebay; I Facebooked.   I didn’t however use any Apple product or service (and probably never will … some habits die hard!)

From an investment perspective, everything I saw and did highlighted the importance of having highly diversified investments.  In this part of the world we have no exposure to the huge US technology sector (Apple, Google, Microsoft, etc), let alone other huge sectors such as automotive and pharmaceuticals.  The US economy is surging ahead, while the NZ economy is slowing.

And lets not forget that the market capitalisation of US stocks is around $30 trillion or just under half of the world’s market cap.  The US is big!  Stock prices have risen significantly over the last few years, but are supported by very strong company earnings.

Granted, there is an unstable president at large in the White House, but despite this, the US seems to be surging forwards, and still looks to me like a good place to invest.

 

Dean Edwards 

 

 

Questions of legacy

Many of the middle aged and retired clients that I see have an understandable desire to leave a legacy for their children – usually in the form of an inheritance of financial assets and/or property.  Often this is a reflection of their upbringing – in many instances they benefited from an inheritance themselves when they were younger – and also an ingrained belief that they should pass on their wealth to their children.

A traditional legacy involves leaving behind your remaining wealth to your children when you die.

However, life expectancies have increased and are likely to increase further, and this raises the question of whether providing an inheritance after you die is leaving it too late.

A person reaching the current retirement age of 65 has a very realistic chance of living to 90 or beyond.  The implications are that children may be aged in their 60s or 70s by the time that person dies.  In fact the children may have retired themselves!  60 or 70 is a relatively advanced age to receive an inheritance.  Financial patterns are set, assets are often well established, and simply put, children of near-retirement age may not have as much need or be able to benefit from an inheritance as much as a younger person.

A better option may be to distribute some of the wealth intended as a legacy well before you die.

Consider some of the advantages:

  • Children are more likely to be at a stage in life where receiving some financial support could be of real benefit – for example, buying a first house.
  • Parents can be actively involved in how the financial support is provided and how it is utilised – ie they can set the rules and are there to provide guidance.
  • Parents will also be able to see their children benefiting from the financial support, which can itself be tremendously satisfying.

To provide a “while-living legacy” you will need to have a good handle on your net worth, how much you are likely to spend as you get older, how those costs can be met, what you will need as a safety net, and the returns you can expect from your investments.  You can then make a (conservative) estimate of what you could provide as a legacy.  If that sounds daunting, a good financial adviser will be able to help.

You may also need to get good legal advice.  Gifting is no longer taxable but there still could be unintended consequences (as there can be with wills and inheritances).  For example, gifts made to a child in a relationship that subsequently ends may find that half of that gift goes to the other partner.

 

Dean Edwards

 

Comparing NZ passive funds

For many investors, their preferred investment style is via passive, index tracking funds.  Passive funds are typically characterised by low management fees, as the funds automatically hold all of the shares within the particular index they track, and don’t need to employ a fund manager/research team to pick stocks that they believe will outperform (this is the domain of Active funds).  Hence the management costs for Passive funds are low compared with Active funds – a significant advantage they hold (for a more detailed look at Active v Passive funds, see my earlier blog post here).

For Passive investors investing in NZ equities, until recently the only choice available (outside of KiwiSaver) was via SmartShares, which offer a range of funds including the NZ Top 50 Fund which, as the name suggests, invests in the 50 biggest NZ companies.  The management fee is 0.5%.

However this position has changed recently, with KiwiSaver/investment fund provider Simplicity introducing the NZ Share Fund.  This also invests in the top 50 NZ listed companies, but significantly, the management fee is a mere 0.1% – one fifth of the fee charged by SmartShares.

On the surface favouring the Simplicity fund looks like a no-brainer.  However, there are some important differences in the two offerings worth noting:

  • The SmartShares fund has a 5% cap on any individual stock, the Simplicity fund doesn’t.  SmartShares argues that the performance of the “capped” index has been better than the uncapped index by 0.63% pa over the last 10 years.
  • For SmartShares, investors can choose to have dividends paid in cash.  For Simplicity, dividends are reinvested.
  • The minimum investment is $250 for SmartShares, $10,000 for Simplicity.

What is my view?

One of reasons I have favoured (good) Active fund managers for NZ investments is that the management fee of the SmartShares passive funds is too high and does not provide a significant enough cost advantage over the (good) Active fund managers.  The Simplicity offering with its 0.1% fee is much more in line with overseas passive fund costs.  It will be interesting to see how SmartShares responds, and if they lower their fees. 

As it stands today, I favour Simplicity over Smartshares for NZ passive investments in the top 50 NZ companies (assuming the investor has the $10k minimum).  The ability to have dividends paid in cash with SmartShares is nice, but of secondary importance.  And I’m not sold by the historical outperformance of the 5% stock cap (this doesn’t mean the capped fund will outperform over the next 10 years).    

As they have done with KiwiSaver, it’s great to see Simplicity also entering the NZ passive investment market, and giving it a good shake up!

 

Dean Edwards

 

Note: I am a fully independent Financial Adviser and do not receive any commissions, payments or incentives from any product providers.